INTRODUCTION

At a very macro level, Investment Banking as term suggests, is concerned with the primary
function of assisting the capital market in its function of capital intermediation, i.e., the
movement of financial resources from those who have them (the Investors), to those who need to
make use of them for generating GDP (the Issuers). Banking and financial institution on the one
hand and the capital market on the other are the two broad platforms of institutional that
investment for capital flows in economy. Therefore, it could be inferred that investment banks are
those institutions that are counterparts of banks in the capital markets in the function of
intermediation in the resource allocation. Nevertheless, it would be unfair to conclude so, as that
would confine investment banking to very narrow sphere of its activities in the modern world of
high finance. Over the decades, backed by evolution and also fuelled by recent technologies
developments, an investment banking has transformed repeatedly to suit the needs of the finance
community and thus become one of the most vibrant and exciting segment of financial services.
Investment bankers have always enjoyed celebrity status, but at times, they have paid the price
for the price for excessive flamboyance as well.
To continue from the above words of John F. Marshall and M.E. Eills,
investment banking is what investment banks do. This definition can be explained in the
context of how investment banks have evolved in their functionality and how history and
regulatory intervention have shaped such an evolution. Much of investment banking in its present
form, thus owes its origins to the financial markets in USA, due o which, American investment
banks have banks have been leaders in the American and Euro markets as well. Therefore, the
term investment banking can arguably be said to be of American origin. Their counterparts in
UK were termed as merchant banks since they had confined themselves to capital market
intermediation until the US investments banks entered the UK and European markets and
extended the scope of such businesses.
Investment banks help companies and governments and their agencies to raise money by issuing
and selling securities in the primary market. They assist public and private corporations in raising
funds in the capital markets (both equity and debt), as well as in providing strategic advisory
services for mergers, acquisitions and other types of financial transactions. Investment banks also
act as intermediaries in trading for clients. Investment banks differ from commercial banks,
which take deposits and make commercial and retail loans. In recent years however, the lines
between the two types of structures have blurred, especially as commercial banks have offered
more investment banking services. In the US, the Glass-Steagall Act, initially created in the wake
of the Stock Market Crash of 1929, prohibited banks from both accepting deposits and

underwriting securities; Glass-Steagall was repealed by the Gramm-Leach-Bliley Act in 1999.

Investment banks may also differ from brokerages, which in general assist in the purchase and
sale of stocks, bonds, and mutual funds. However some firms operate as both brokerages and
investment banks; this includes some of the best known financial services firms in the world.
More commonly used today to characterize what was traditionally termed investment banking
is sells side." This is trading securities for cash or securities (i.e., facilitating transactions,
market-making), or the promotion of securities (i.e. underwriting, research, etc.).

Definition
An individual or institution, which acts as an underwriter or agent for corporations and
municipalities issuing securities. Most also maintain broker/dealer operations, maintain markets
for previously issued securities, and offer advisory services to investors. Investment banks also
have a large role in facilitating mergers and acquisitions private equity placements and corporate
restructuring. Unlike traditional banks, investment banks do not accept deposits from and provide
loans to individuals.

Investment banking process

Issue
r
2

Securities

Issuer

Investment
Banker

Investor

Cash

History of Investment banking

Given its history, merchant banking is often thought of as a European, and especially British,
financial specialty, and British institutions continue to maintain a major presence in this area.
Since the 1800s and even earlier, however, U.S. firms (such as J.P. Morgan) also have been active
in merchant banking. However, although both investment banks and commercial banks, as well as
other types of businesses, have been authorized to engage in private equity investment in the
United States, financial institutions have not been major providers of private equity.
Until the 1950s, U.S. investors in private equity were primarily wealthy individuals and families.
In the 1960s and 1970s, corporations and financial institutions joined them in this type of
investment. (In the 1960s, commercial banks were the major providers of one kind of private
equity investing, venture-capital financing.) Through the late 1970s, wealthy families, industrial
corporations, and financial institutions, for the most part investing directly in the issuing firms,
constituted the bulk of private equity investors.
In the late 1970s, changes in the Employee Retirement Income Security Act (ERISA) regulations,
in tax laws, and in securities laws brought new investors into private equity. In particular, the
Department of Labor's revised interpretation of the "prudent man rule" spurred pension fund
investment in private equity capital. Currently, the major investors in private equity in the United
States are pension funds, endowments and foundations, corporations, and wealthy investors;
financial institutions-both commercial banks and investment banks-represent approximately 20
percent of total private equity capital, divided approximately equally between the two. The U.S.
Department of the Treasury (Treasury) estimates that at year-end 1999, commercial banks
accounted for approximately $35 billion to $40 billion and investment banks for approximately
another $40 billion, of the $400 billion total investment in the private equity market.
At $400 billion as of year-end 1999, the private equity market is approximately one-quarter the
size of the commercial and industrial bank-loan market and the commercial-paper market. In
recent years, funds raised through private equity have approximately equaled and sometimes
exceeded funds raised through initial public offerings and public high-yield corporate bond

issuance. The market also has grown dramatically in recent years, increasing from approximately
$4.7 billion in 1980 to its 1999 figure. Despite this tremendous growth, the private equity market
is extremely small compared with the public equity market, which was approximately $17 trillion
at year-end 1999

Evolution of investment banking in India

The origin of investment banking in India can be traced back to the late 19th century when
European merchant banks set up their agency house in the country to assist in the setting up of
new projects. In the early 20th century large business houses followed suit by establishing
managing agencies which acted as issue house for securities, promoters for new projects and also
provided finance to green field ventures. But these entire roles were limited to small capital base.
In 1967, ANZ Grindlays bank set up separate Merchant banking division to handle new capital
issues. It was soon followed by CitiBnak, which started rendering Merchant Banking services.
The foreign banks monopolized merchant banking services in the country. The banking
commission, in its report in 1972, took note if this with concern and recommended setting up of
merchant banking institutions by commercial banks and financial institutions. SBI ventured into
this business by starting a merchant business bureau in 1972. In 1973, ICICI became the first
financial institutions to offer merchant banking. JM finance was set up in 1973. The growth of
industry during that period was very slow. The industry remained more or less stagnant in the
eighties.
The capital market witnessed some buoyancy in the late eighties. The advent of economic
reforms in 1991 resulted in a sudden spurt in both the primary and secondary market. Several new
players entered into the field. The securities scam in may, 1992 was a major setback to the
industry. Several leading merchant banker, both in public and private sector were found to be
involved in various irregularities, some of the prominent public sector players involved in the
scam were canbank financial services and champaklal investment and finances. The markets
turned bullish again in the end of 1993 after the tainted shares problems were substantially
resolved. The registration norms with SEBI were quiet liberal. Many foreign investment bankers
stated entering in India in tie ups with Indian player. Some of tie ups player were

JM Finance- Morgan Stanley

DSP Financial consultants- Merill lynch

Kotak Mahindra- Goldman Sachs

SBI Capital Markets Lehman Brothers

In India merchant banker can be segregated as follows, depending on the sector to which they
belong.
1. Public sector Merchant bankers
a. Commercials banks.
b. National Financial Institutions.
c. State financial institutions.
2. Private sector Merchant Bankers
a. Foreign Bankers
b. Indian private Banks
c. Leasing Banks.
d. Financial and Investment companies.
The current of the investment banking industry is in state of flux. The current transition phase is
witnessing a paradigm shift in the nature and composition of this industry. The industry was
hitherto synonymous with issue management and underwriting. Investment bankers have stared
diversifying into new function such M&A, new products, new techniques.

Who needs an Investment Bank

Any firm contemplating a significant transaction can benefit from the advice of an investment
bank. Although large corporations often have sophisticated finance and corporate development
departments provide objectivity, a valuable contact network, allows for efficient use of client
personnel, and is vitally interested in seeing the transaction close. Most small to medium sized
companies do not have a large in-house staff, and in a financial transaction may be at a
disadvantage versus larger competitors. A quality investment banking firm can provide the
services required to initiate and execute a major transaction, thereby empowering small to
medium sized companies with financial and transaction experience without the addition of
permanent overhead, an investment bank provides objectivity, a valuable contact network, allows
for efficient use of client personnel, and is vitally interested in seeing the transaction close. Most
small to medium sized companies do not have a large in-house staff, and in a financial transaction
may be at a disadvantage versus larger competitors. A quality investment-banking firm can
provide the services.

The main activities and units

The primary function of an investment bank is buying and selling products both on behalf of the
bank's clients and also for the bank itself. Banks undertake risk through proprietary trading, done
by a special set of traders who do not interface with clients and through Principal Risk, risk
undertaken by a trader after he or she buys or sells a product to a client and does not hedge his or
her total exposure. Banks seek to maximize profitability for a given amount of risk on their
balance sheet
An investment bank is split into the so-called Front Office, Middle Office and Back Office. The
individual activities are described below:

Front Office

Investment Banking is the traditional aspect of investment banks which involves helping
customers raise funds in the Capital Markets and advising on mergers and acquisitions.
Investment bankers prepare idea pitches that they bring to meetings with their clients,
with the expectation that their effort will be rewarded with a mandate when the client is
ready to undertake a transaction. Once mandated, an investment bank is responsible for
preparing all materials necessary for the transaction as well as the execution of the deal,
which may involve subscribing investors to a security issuance, coordinating with
bidders, or negotiating with a merger target. Other terms for the Investment Banking
Division include Mergers & Acquisitions (M&A) and Corporate Finance (often
pronounced "corpfin").

Investment management is the professional management of various securities (shares,

bonds etc) and other assets (e.g. real estate), to meet specified investment goals for the
benefit of the investors. Investors may be institutions (insurance companies, pension
funds, corporations etc.) or private investors (both directly via investment contracts and
more commonly via collective investment schemes e.g. mutual funds) .

Financial Markets is split into four key divisions: Sales, Trading, Research and
Structuring.

Sales and Trading is often the most profitable area of an investment bank ,
responsible for the majority of revenue of most investment banks In the process of
market making, traders will buy and sell financial products with the goal of making
an incremental amount of money on each trade. Sales is the term for the investment
banks sales force, whose primary job is to call on institutional and high-net-worth
investors to suggest trading ideas (on caveat emptor basis) and take orders. Sales
desks then communicate their clients' orders to the appropriate trading desks, which
can price and execute trades, or structure new products that fit a specific need.

Research is the division which reviews companies and writes reports about their
prospects, often with "buy" or "sell" ratings. While the research division generates no
revenue, its resources are used to assist traders in trading, the sales force in
suggesting ideas to customers, and investment bankers by covering their clients. In
recent years the relationship between investment banking and research has become
highly regulated, reducing its importance to the investment bank.

Structuring has been a relatively recent division as derivatives have come into play,
with highly technical and numerate employees working on creating complex
structured products which typically offer much greater margins and returns than
underlying cash securities.

Middle Office

Risk Management involves analyzing the market and credit risk that traders are taking
onto the balance sheet in conducting their daily trades, and setting limits on the amount of
capital that they are able to trade in order to prevent 'bad' trades having a detrimental
effect to a desk overall. Another key Middle Office role is to ensure that the above
mentioned economic risks are captured accurately (as per agreement of commercial terms
with the counterparty) correctly (as per standardized booking models in the most
appropriate systems) and on time (typically within 30 minutes of trade execution). In
recent years the risk of errors has become known as "operational risk" and the assurance
Middle Offices provide now include measures to address this risk. When this assurance is
not in place, market and credit risk analysis can be unreliable and open to deliberate
manipulation.

Back Office

Operations involve data-checking trades that have been conducted, ensuring that they are
not erroneous, and transacting the required transfers. While it provides the greatest job

security of the divisions within an investment bank, it is a critical part of the bank that
involves managing the financial information of the bank and ensures efficient capital
markets through the financial reporting function. The staff in these areas are often highly
qualified and need to understand in depth the deals and transactions that occur across all
the divisions of the bank.

Functions of the merchant banking divisions are as follows:

1. Advice and liaison obtaining consent of the Central and Stat e Government, for the

project if necessary;
2. Preparation of economic, technical and financial feasibility reports;
3. Initial project preparation, pre-investment survey, and market studies;
4. Help in raising rupee resources from financial institutions and commercial banks;
5. Underwriting and also for subscription, if necessary, to the new issues or syndication
of loans, etc;
6. Assistance in raising foreign exchange resources so as to enable the industrial
concerns to import machinery and technical know-how and secure foreign
collaboration.
7. Advice on setting up turnkey project s in foreign countries and locating foreign
markets;
8. Help in financial management and in designing proper capital structure and debtequity ratio, etc, for the company.
9. Advice on restructuring of capital, amalgamation, mergers, takeovers, etc;
10. Management of investment trust, charitable trusts etc;
11. Management aid and entrepreneurial aid (management audit providing designs of the
complete system, operational research and management consultancy); and
12. Recruitment (selection of technical and managerial personnel), etc.

Scope of investment Banking

The Investment banker plays a vital role in channel zing the financial surplus of the society into
productive investment avenues. The merchant banker has fiduciary role in relation to the investor.
Some of the major functions performed by investment banker are as follows.
1. Management of debt and equity offering This is the traditional bread and butter
operations for most of the investment banker in India. The role of the investment banker is
dynamic and it has to be nimble footed to capitalize on available opportunities. It has to assist
its clients in raising fund from the market. It may also be required to counsel them on various
issues that affect their finances. The main area of its role includes:
Instrument Designing
Pricing the issue
Registration of the offer document
Underwriting the support
Marketing the issue
Allotment and refund

 Listing on stock exchange

Listing on stock exchange
2. Placement and distribution The distribution network of Investment banker can be
classified as institutional and retail. The network of institutional investors consist of Mutual
Funds, FIIs, bank, domestic and multinational financial institutions, PE, pension funds, etc. the
size of this network represent the wholesale reach of the Investment banker. The basic
requirement to create and service the institutional segment is the existence of good in-house
research facilities. The investment proposal should be accompanied by high quality research
reports of the Investment banker to justify the investment recommendation. The retail distribution
reach depends upon the networking with the investors. Many Investment banks have associate
firms which are brokers on the stock exchange. These brokers appoint sub-brokers at various
locations to service both the primary market and secondary market needs of the local investors.
Thus a large base of captive investors is created and maintained.

The distribution network can be used to distribute various financial products like:

Equity

retail and institutional investors

Debt Instruments

retail and institutional investors

Mutual Fund products :

retail investors

Fixed deposits

retail investors

Insurance products

retail investors

Commercial paper

institutional investors

10

3. Corporate advisory Services - investment bankers offers customized solutions to the financial
problem of their clients. One of the key areas for advisory role is financial structuring. The
process includes determining the appropriate level of gearing and advising the company whether
to leverage, de-leverage or maintain its current debt-equity levels. The asset turnover ratios may
be analyzed to study whether the company is over trading or under trading. The companys
working capital practices are studied and alternative working capital policies are suggested. The
investment banker may also explore the possibility of refinancing high cost funds with alternative
cheaper funds. They play advisory role in securitization of receivables. They also help their cash
rich clients in deployment of their short-term surpluses.
4. Project Advisory - investment bankers are associated with their clients from the early stage of
their project. They assist the companies in conceptualizing the project idea when it is at nebulous
stage. Once the project is conceptualized, they carry out the initial feasibility studied to examine
its viability. Investment bankers provide inputs to their clients in preparation of the detailed
project report. They also offer project appraisal services to clients.
4. Loan syndication - investment bankers arrange to tie up loans for their clients. The first step
involves analyzing the clients cash flow pattern so that terms of borrowing can be defined to suit
the cash flow requirements. The important loan parameters include amount, currency, tenure,
drawdown, moratorium and the amortization. The investment bankers then prepare the detailed
loan memorandum. The loan memorandum is then circulated to various banks and financial
institutions and they are invited to participate in the syndicate.
The banks indicate the amount of exposure of service they are willing to take and the interest
rates thereon. The terms are further negotiated and fine- tuned to the satisfaction of both parties.
The final allocation is done to the various members of the syndicate. The investment banker also
helps the clients in loan documentation procedures.

11

5. Research Services - Nearly all banks have a staff of research analysts who study economic
trends and news, individual company stocks, and industry developments to provide proprietary
investment advice to institutional clients and in-house groups, such as the sales and trading
divisions. Until recently, the research division has also played an important role in the
underwriting process, both in wooing the client with its knowledge of the clients industry and in
providing a link to the institutions that own the clients stock once its publicly traded. Indeed, in
many cases, research analysts compensation was tied to investment banking revenues. However,
in recent times banks have faced public and regulatory outcries over conflicts of interest inherent
in having bankers and researchers work hand in hand. As a hypothetical example, consider Bank
A, which counts Company X, which is facing financial difficulties, among its banking clients.
Should Bank As research team pan Company Xs stock, which would benefit investors who
subscribe to Bank As research, but might upset Company X to the point that it drops Bank A and
hires another firm to be its investment banker? Or should it recommend the purchase of Company
X stock, which would help Company X financially and keep the banking revenues from
Company X rolling inand pump up research analysts bonuses, which are based in part on the
success of Bank As banking operations? In an effort to end the legal scrutiny of their operations,
investment banks are now attempting to reinforce the separation between their banking and
research arms. You can certainly count on research playing a lesser role in selling banking deals.
Also, independent research houses (e.g., Needham & Co., Sidoti & Co., and JMP Securities) are
benefiting in a big way from a settlement between the investment banking industry and regulators
that requires investment banks to spend a total $432.5 million over 5 years to give clients
independent research. And as the full service investment banks move to purchase independent
research, as theyre required to do by regulators, certain research specialistsStandard & Poors
and BNY Jay hawk (which actually aggregates research from more than 100 research
organizations)are looking like theyre going to make out handsomely.

6. Venture capital - Venture capital is risks money, which is used in risky enterprises either as
equity or debt capital. It may be in new sunshine industries or older risk enterprises. The funds,
which finance such risky, are called venture capital funds. Venture capital is a post-war
phenomenon in the business world, mainly developed as a sideline activity of the rich in USA. To
connote the risk & adventure & some element of investment, the generic name of venture
capital was coined. In the late 1960s a new breed of professional investors called venture
capitalists emerged whose specialty was to combine risk capital with entrepreneurial management
& to use advance technology to launch new products and companies in the markets place.
Undoubtedly, it was venture capitalists astute ability to assess and manage enormous risks &
export from them tremendous returns that changed the face of America. In developed countries,

12

this capital came from pension funds, insurance companies & even large banks. Some large
companies with excess funds may provide this capital to achieve diversification, market
expansion & window on technology or to share in this result of R&D of others.
In India, as the majority of the above institutions are in the public sector, only the
government or public financial institutions can provide the funds for venture capital. Venture
capital is a post-war phenomenon in the business world, mainly developed as a sideline activity
of the rich in USA. To connote the risk & adventure & some element of investment, the generic
name of venture capital was coined. In the late 1960s a new breed of professional investors
called venture capitalists emerged whose specialty was to combine risk capital with
entrepreneurial management & to use advance technology to launch new products and companies
in the markets place. Undoubtedly, it was venture capitalists astute ability to assess and manage
enormous risks & export from them tremendous returns that changed the face of America.
Innovative, hi-tech ideas are necessarily risky. It is here that the concept of venture capital
steps in. Venture Capital provides long start up costs to high risks & returns project. Typically,
these projects have mortality rates and therefore are unattractive to risks-averse bankers & private
sectors companies.
Venture Projects
Proposals come to the venture capitalists in the form of business plans. He appraises the
same, giving due regard to the credentials of the founders, the nature of the product or services to
be developed, the market to be saved & the financing required. If satisfied, he will invest his own
money in the equity shares of the new company, known as the assisted company. In addition to
money, managerial & marketing assistance may also be provided that is, the venture capitalist not
only provides funds but also on line operational advice. In short, he identifies himself with the
project as much as the innovator promoter & as such works hard to accomplish ambitious targets
& consequents higher appreciation of his capital.
Indian Position in venture capital
In India, most project financing schemes require at least 25 per cent of the project
cost to be contributed by the promoters, while the latter can raise barely 5-10 percent. For long,
there were a few agencies such as IFCIs subsidiary company, Risks Capital And Technology
Foundation of India, which provides finance to bridge the shortfall in the promoter contribution,
but they could fulfill the requirements of a great many budding entrepreneurs. As results of
promoters not being able to bring in those vital initial inputs of money, many of their good

13

projects were hanging fire. Venture capital could remedy this situation as well.

A beginning was made in this direction by the setting up of venture capital

divisions under the aegis of ICICI, IDBI & IFCI. Encouraged by the response to technology
financing, ICICI floated a separate company ---Technology Development and Information
Company of India (TDICI) includes, apart from venture capital financing, technology,
consultancy as well as entrepreneur escort services such as marketing, business management,
vendor development etc. The successful operation of this fund will hopefully spark off some
interest from the private sector, which will then consider entering this line of activity. Ultimately,
it is only when venture capital financing becomes more broad-based and widespread that it will
truly taking root in economy. In tune with its tradition of pioneering new ideas, ICICI deviated
from the beaten path to usher in an unusual type of financial support. Addition to equity
participation (up to maximum of 49 percent) undertaken by typical venture capital companies,
TDICI offer the conditional loans. The entrepreneur neither pays interest on it nor does he have to
repay the principal amount. If the venture capital succeeds, TDICI recoups its investment in the
form of royalty on sales which ranges between two and eight percent. On the other hand, if the
venture fails to take off even after five years TDICI will consider writing off the loan.

Agencies for Financing Venture Capital

1. Public financing agencies: - It is to be noted that the floating venture capital companies
are the financial institutions or banks (the Andhra Pradesh Industrial Development
Corporation, Canara bank and others). This can be directly attributed to the Government
guidelines, which restrict private sector participation in venture capital funds to a
maximum of 20 percent.
But if the concept is to make a mark in the economy it needs private sector
initiative and not institutional or government patronage. In fact, herein lies the strategic
significance of the venture capital. It paves, the way for the private sector to share the
burden of industrial finance, particularly risk finance with the public sector.
The activities of the venture capital fund of ANZ Grindlays bank include making
equity investments in new companies, which may or may not involve any new
technology or other such related risk. This activity of the direct subscriptions by financial
institutions and banks has been going on for decades and cannot be termed as venture
capital activity. The difference in ANZ Grindlays bank activity is one of the nomenclature
and not of means of financing. Also, on the whole, venture capital is provided more in the
nature of mezzanine loans than equity.

14

2. Private Agencies:- One Venture Capital fund set up the private sector in India is Credit
Capital Venture Capital (India) or CVF for the short, the principal shareholders of which
are Credit Capital Finance Corporation, Bank of India, Asian Development Bank, and
Commonwealth Development Corporation. Another set up in the private sector jointly by
the ICICI 20th Century Finance Corporation, bank of Baroda, Asian development Bank
and Asian Finance and investment Corporation is the 20th Century Venture Capital
Corporation Ltd. One reason why private capitalists are generally shy may be the high
rate of capital gains tax applicable to the profit of Venture Capital Funds. Though the
guidelines provide for a concessional rate of capital gains tax, the move can hardly be
deemed as a concession in view of the enormous risks involved in the activity.

Policy Initiatives for venture capital

The idea of providing venture capital finance (VCF) to the new entrepreneurs in
India was mooted by the then finance minister in the long-term fiscal policy announced by him in
1985. A fresh reference to the difficulties faced by new entrepreneurs in raising equity capital
was made by the finance minister in his 1988-89 budget speech and detailed guidelines for
providing such finance by registered companies or funds were announced. In India, the
government has set up a Venture Capital Funds with a contribution of Rs.10crore. The fund was
brought into operation on 1st April 1986 by the IDBI. For financing this fund, a levy was imposed
on all payments made by Indian industries for the acquisition of foreign technologies. This fund
finance projects with minimum and maximum project costs of Rs.5lakhs and Rs.250lakhs
respectively. Grindlays Bank has set up the Indian Investment Fund to Finance the start up cost of
entrepreneurs. This fund was subscribed mainly by Non-resident Indians. The Government of
India also announced on 1989 a National Equity Fund for financing small-scale entrepreneurs
setting up units in rural areas and urban areas population of below Rs.5lakhs. Institutions like
ICICI, IFCI, SBI Capital Markets Canbank Financial Services and others have also set up their
own funds for providing Venture Capital Finance.
However, in general, the experience is that the Indian financial institutions are yet to
reorient their financing policies to meet the Venture Capital maxims. The traditional conservation
of these organizations makes their approach unacceptable. They fail to recognize that normal
criteria of debt-equity ratio, existence of security etc., are not the criteria for evaluating venture
capital projects. The policy of Government with regard to Venture Capital Funds has changed in

15

1999-2000. The Government has allowed a free hand and transparency for I.T. Venture Funds
Foreign Funds are allowed freely into these Funds.

Difficulties in India
Fundamentally, there are no private pools of the capital of finance risk ventures in
India. The financial institutions perforce occupy a dominant position in the provision of long-term
capital to Indian industry. They and the State development agencies do provide limited amount of
equity finance to assist the development of new business but there is no private, professionally
managed investment capital sources. There are no private sector insurance companies or the
pension funds gathering regular premium income and virtually no private banks willing to devote
a small portion of their resources to the venture capital niche. It is unlikely that such enterprises
will be created in the foreseeable future to mobilize private saving for investments. As an answer
the situation, mutual funds and investment trusts are permitted to set up and to commit the part of
their resources to the venture capital area. As a part of the broader equity investment fund, given
suitable standards of the valuation for unquoted investments, it should be possible for the fund
managers to commit the portion of there portfolios to venture capital situations. The participation
of the private sector in venture capital funding, as it has come to be defined in the narrow Indian
context, is not possible in isolation from the opportunity to develop a broadly spread investment
business.

Tax Treatment for venture capital

The tax treatment of the venture capital funds in India is ungenerous and falls well short
of what is required. Whereas the Mutual Funds established by the government controlled
financial institutions and nationalized commercial bank suffer no tax on either income or capital
gains, a venture capital fund would suffer at 20 per cent on dividend income and a similar rate on
long-term capital gains. Given an adequate investment spread and tax incentives, mutual funds
step into the early stage financing arena, professionally assess and the monitor investments assist
the launch of new medium size businesses. SBI Mutual Fund is really undertaking investment
work with its brought deals. The creation of more funds to participate in this area of the market
is now clearly seen. Early stage financings could then be syndicated between number of
professionally managed funds and sound, competitive situation between them might also be
created.
The Government has since 1995-96 been treating the venture funds like Mutual funds for
tax benefits and brought them under Regulation of SEBI. The SEBI has set out the guidelines for
their registration and control by itself a code of conduct for them to operate as in the case of
capital market mutual funds and for their investment and operations on the fund. In the Central

16

Budget for 2000-01 the income of the Venture Capital Fund is taxed at the rate of 20%, although
the dividends declared in the hands of the investors are tax-free.

Need for Growth of Venture Capital:

There is need for encouragement of risk capital in India, as this will widen the
industrial base of, high-tech industries and promote the growth of technology. The initial step
might be to permit the launch of the mutual fund by all those banks authorize to conduct business
in India, at the same time extending the investment range of such funds to embrace unquoted
stocks.
Liberating the capital market would bring greater depth to the capital market as a
whole, introducing more genuine investors of substance with long time horizons, provide avenues
for the institutions to realize their equity portfolios more easily (freeing funds for more new
investments), and generally improve market liquidity. This would improve equity cult.
So moves towards a freer and less regulated market are important in considering
measures to simulate the entry of the private sector into the risk capital formation.

Latest Policy Charges for venture capital

In the year of 2000 of new millennium, the I.T. industry along-with many start up
industries like Telecom, Biotech, Multimedia etchave experienced rapid growth potential but
with Scarcity of the Venture Funds. To encourage Venture Capital Funds to grow rapidly to help
these industries, the Government has announced the following measures early in 2000.
1. SEBI to be the sole authority for the regulation of Venture Capitals.
2. The single window clearance facility is extended without the need for going for clearance
with the government RBI and I.T. Authorities.
3. In the first Millennium Budget, 2000-2001, Venture Capital have got on par Status with
Mutual Funds for the purpose of the tax treatment under section 10(23D) of I.T. Act. Tax
exemption is granted to Venture Capitals like those of Mutual Funds, so that double
taxation is avoided and tax is levied only at one level, namely at the hands of investors.
4. The IPO norms are liberalized for the Venture Capital Funds for the purpose of listing.
Appraisal and finding are allowed to extent of 10% of the equity capital of a start-up
company. The condition of 3 years track record of profitability is waived. Even a public
issue of 10% of paid up capital is enough for the I.T companies for the purpose of listing.

17

5. The Government have set up a separate ministry of I.T and started an I.T Venture Fund of
Rs.100crores for the financing new start up I.T projects.
6. Venture Funds were set up by ICICI, UTI, IDBI, Tatas etc.

Rules on Venture Capital Funds

The norms of Venture Capital Funds are liberalized early January 2000. While
earlier, a Venture Capital Funds could not acquire more than 40% of equity of a high risk business
or a start up company, now there is no such ceiling and Venture Capital Funds is free to invest as
it likes. However, the only restriction that remains is that the Venture Capital Funds cannot invest
more than 25% of its own Fund base in any one company. Now Venture Capital Funds can hold
up to even 100% of equity of a start up the company as that ceiling of 40% is now removed, but it
can now hold up to 25% of its own fund in any companys equity.
Foreign Venture Capital is made eligible to participate in book building process
since July 2001. There is no lock in period for the pre issue share capital of an unlisted company
held by Venture Capital Funds and FVCFs. Mutual Funds are now eligible to invest in units of the
Venture Capital Funds, like investments in listed and unlisted securities. There has been a
considerable liberalization in investments by Venture Capital Funds as much as investments in
Venture Capital Funds.

7. Merger and acquisitions M&A are becoming increasingly significant in term of services
offered by the investment bankers in India. During the licensing era, several companies had
indulged in unrelated diversifications depending on the availability of the licenses. The
companies thrived in spite of their inefficiencies because the total capacity in the industry was
restricted due to licensing. The companies over a period of time became unwieldy conglomerates
with suboptimal portfolio of assorted business. The policy of decontrol and liberalization coupled
with globalization of the economy has exposed the corporate sector to serve domestic and global
competition. The industry is passing through a transitory phase of restructuring. The mergers and
acquisitions group provides advice to companies that are buying another company or are those
selves being acquired. M&A work can seem very glamorous and high profile. At the same time,
the work leading up to the headline-grabbing multibillion-dollar acquisition can involve a
Herculean effort to crunch all the numbers, perform the necessary due diligence, and work out the
complicated structure of the deal. As one insider puts it, You have to really like spending time in
front of your computer with Excel. Often, the M&A team will also work with a corporate
finance industry group to arrange the appropriate financing for the transaction (usually a debt or
equity offering). In many cases, all this may happen on a very tight timeline and under extreme

18

secrecy. M&A is often a subgroup within corporate finance; but in some firms, it is a stand-alone
department. M&A can be one of the most demanding groups to work for.

M&A benefits the following

Financial:
I. Benefits on account of tax shield.
II. Restructuring and strengthening the balance sheet.
III. Profiting from leveraged buyouts.
IV. Investment of surplus cash.

Marketing
I. Increase in market share.
II. Elimination of competition.
III. Diversification of risks.
IV. Growth without increase in the capacity.

Production
I. Horizontal and vertical integration.
II. Acquisition of new technology.

Classifications of mergers

Horizontal mergers take place where the two merging companies produce similar
product in the same industry.

Vertical mergers occur when two firms, each working at different stages in the
production of the same good, combine.

Con-generic merger/concentric mergers occur where two merging firms are in the
same general industry, but they have no mutual buyer/customer or supplier
relationship, such as a merger between a bank and a leasing company. Example:
Prudential's acquisition of Bache & Company.

Conglomerate mergers take place when the two firms operate in different industries.

M&Q requires following step

(i) Acquisition search: - the first step is to determine the universe of potential target
companies. Information is gathered about these companies based on their published data,
industry specific journals, database etc. if the acquisition involves buying only part of the
target company, segmental data may be difficult to obtain. Similarly, information about
private companies may not be readily available. Once the universe is determined, targets
may be short listed based on those parameters.

19

(ii) Approaching the target: - This is one of the most critical roles played by the investment
bankers in the deal. There are broadly two methods of approaching the targets- passive
strategy i.e. no aggressive approach is used and active strategy i.e. acquisition may be
friendly or hostile.
(iii) Valuation: - valuation of the target company is the most critical task performed by the
investment banker. A conservative valuation can result in collapse of the deal while an
aggressive valuation may create perpetual problems for the acquiring company. The
commonly used valuation methods are
(a) Discounted cash flow method.
(b) Comparable companies method
(c) Book value method
(d) Market value method
(iv) Negotiation: - This is the process of formulating the structure of the deal. The investment
banker plays a vital role in closing the financial side of the negotiation. From a financial
standpoint, the key elements of negotiations are the price and the form of consideration.
Both the elements are interrelated and affect the attractiveness of the deal. The merchant
banker must ensure that the final price paid should not exceed the perceived value of the
targets to the acquirer.
(v) Acquisition finance: - once the negotiation is over and the price is finalized, the merchant
banker has to assist the acquirer in arranging the required finance. The consideration can be
paid in the form of cash, debt securities or equity of the acquiring company. Cash may be
raise from the internal accruals, sale of assets, etc. It may also be refinanced by bank
borrowing, public issue or private placement of debt and equity.

8. Initial Public Offerings: - Initial Public Offerings (IPO) is the first time a company sells its
stock to the public. Sometimes IPOs are associated with huge first-day gains; other times, when
the market is cold, they flop. It's often difficult for an individual investor to realize the huge
gains, since in most cases only institutional investors have access to the stock at the offering
price. By the time the general public can trade the stock, most of its first-day gains have already
been made. However, a savvy and informed investor should still watch the IPO market, because
this is the first opportunity to buy these stocks.

20

Reasons for an IPO: -

When a privately held corporation needs to raise additional capital, it

can either take on debt or sell partial ownership. If the corporation chooses to sell ownership to
the public, it engages in an IPO. Corporations choose to "go public" instead of issuing debt
securities for several reasons. The most common reason is that capital raised through an IPO does
not have to be repaid, whereas debt securities such as bonds must be repaid with interest. Despite
this apparent benefit, there are also many drawbacks to an IPO. A large drawback to going public
is that the current owners of the privately held corporation lose a part of their ownership.
Corporations weigh the costs and benefits of an IPO carefully before performing an IPO.

Going Public
If a corporation decides that it is going to perform an IPO, it will first hire an
investment bank to facilitate the sale of its shares to the public. This process is commonly called
"underwriting"; the bank's role as the underwriter varies according to the method of underwriting
agreed upon, but its primary function remains the same.
In accordance with the SEBI act, the corporation will file a registration statement with the
Securities Exchange Board of India (SEBI).The registration statement must fully disclose all
material information to the SEBI including a description of the corporation, detailed financial
statements, biographical information on insiders, and the number of shares owned by each
insider. After filing, the corporation must wait for the SEBI to investigate the registration
statement and approve of the full disclosure.
During this period while the SEBI investigates the corporation's filings, the underwriter will try to
increase demand for the corporation's stock. Many investment banks will print "tombstone"
advertisements that offer "bare-bones" information to prospective investors. The underwriter will
also issue a preliminary prospectus, or "red herring", to potential investors. These red herrings
include much of the information contained in the registration statement, but are incomplete and
subject to change. An official summary of the corporation, or prospectus, must be issued either
before or along with the actual stock offering.
After the SEBI approves of the corporation's full disclosure, the corporation and the
underwriter decide on the price and date of the IPO; the IPO is then conducted on the determined

21

date. IPOs are sometimes postponed or even withdrawn in poor market conditions.

Performance
The aftermarket performance of an IPO is how the stock price behaves after the day of its
offering on the secondary market (such as the BSE or the NSE). Investors can use this
information to judge the likelihood that an IPO in a specific industry or from a specific lead
underwriter will perform well in the days (or months) following its offering. The first-day gains
of some IPOs have made investors all too aware of the money to be had in IPO investing.
Unfortunately, for the small individual investor, realizing those much-publicized gains is nearly
impossible. The crux of the problem is that individual investors are just too small to get in on the
IPO market before the jump. Those large first-day returns are made over the offering price of the
stock, at which only large, institutional investors can buy in. The system is one of reciprocal back
scratching, in which the underwriters offer the shares first to the clients who have brought them
the most business recently. By the time the average investor gets his hands on a hot IPO, it's on
the secondary market, and the stock's price has already shot up.

Appointment of Investment Bankers and Other Intermediaries

The company first selects the Investment Banker(S) for handling the issue. The
investment banker should have a valid SEBI registration to be eligible for appointment.
The criteria normally used in selection of Investment Bankers are:
i.

Past track record in successfully handling similar issues

ii.

Distribution network with institutional and individual investors

iii.

General reputation in the market

iv.

Trained manpower and skills for instrument designing and pricing

v.

Good rapport with other market intermediaries

vi.

Value added services like providing bridge loans against public issue proceeds

Issue in any of the capacities

An investment banker can be associated with the issue in any of the following capacities:

Lead Manager to the issue

Co Manager to the issue

Underwriter to the issue

22

Advisor/Consultant to the issue

SEBI has set certain limits on the maximum no of intermediaries associated with the
issue
Size of the issue

No of lead managers

Less than Rs 50cr

Rs 50cr to Rs 100cr

2
3

Rs 100cr to Rs 200cr

Rs 200cr to Rs 400cr

Above Rs 400cr

5 or more as agreed by the board

The no of co managers cannot exceed no of lead managers appointed for that issue.
There can be only one advisor or consultant to the issue. There is no limit on the no of
underwriters to the issue. An associate company of the issuer company cannot be
appointed either as lead manager or Co manager to the issue. However they can be
appointed as Underwriter or Advisor/Consultant to the issue. The lead investment banker
enters into a MOU with the issuer company. The no of co managers cannot exceed no of
lead managers appointed for that issue. There is no limit on the no of underwriters to the
issue. An associate company of the issuer company cannot be appointed either as lead
manager or Co manager to the issue. However they can be appointed as Underwriter or
Advisor/Consultant to the issue. The lead investment banker enters into a MOU with the
issuer company. MOU specifies the mutual rights, obligations and liabilities relating to
the issue. The lead investment banker has to ensure that copy of MOU is submitted to the
board along with the draft offer document. In case of more than one lead manager is
appointed, all lead managers have a meeting and the entire issue related work is
distributed among them. This agreement is called as Inter-se Allocation of
Responsibilities. Once the lead manager(s) is/are appointed, the other intermediaries are
appointed in consultation with them. The selection of the intermediary is based on their
past records, ranking, previous relationship with the issuer company, fees charged etc
The other intermediaries appointed are:
a. Registrar to the issue
b. Bankers to the issue
c. Underwriters to the issue
d. Debenture trustees (if applicable)
e. Brokers to the issue
f.

Advertising agencies

23

g. Printers of issue stationery

h. Auditor
i.

Legal advisor to the issue

9. Working capital: - Working capital, also known as net working capital, is a

financial metric which represents operating liquidity available to a business. Along with
fixed assets such as plant and equipment, working capital is considered a part of
operating capital. Finance for working capital, particularly for new ventures, often needs
to be syndicated on behalf of the promoters, and merchant banks assist in this as well.
For existing companies, non/traditional sources such as through the issue of debentures
for this purpose, and others have been successfully tapped by merchant bankers. This
ensures that the firm is able to continue its operations and that it has sufficient cash flow
to satisfy both maturing short-term debt and upcoming operational expenses

10. Foreign currency finance: - Of late, India has become increasingly active in the
international money markets, and this trend is likely to continue. For import of capital
goods and services from overseas, the arrangement of various kinds of export credits
from different countries is also required.
In addition to this wide range of services, some of the larger banks are also involved in
areas such as the arrangement of lease finance, and assistance in acquisitions and mergers
etc.

11. Underwriting: - Underwriting refers to the process that a large financial service provider
(bank, insurer, investment house) uses to assess the eligibility of a customer to receive their
products (equity capital, insurance, mortgage or credit). This is a way of placing a newly issued
security, such as stocks or bonds, with investors. A merchant banker underwrites the transaction,
which means they have taken on the risk of distributing the securities. Should they not be able to
find enough investors, they will have to hold some securities themselves. Underwriters make their
income from the price difference (the "underwriting spread") between the price they pay the
issuer and what they collect from investors or from broker-dealers who buy portions of the
offering. When a dealer bank purchases Treasury securities in a quarterly Treasury bond auction,
it acts as underwriter and distributor. Treasury securities purchased by a primary dealer are held
in a dealer bank's trading account assets portfolio, and they are often resold to other banks and to
private investors. The main work of merchant banks relates to underwriting of new issues and
rising of new capital for the corporate sector. Of the amount underwritten, some part devolves on
the underwriters, which varies depending on the state of the capital market, and the intrinsic
worth of the project. The SEBI has made underwriting Compulsory for all issues offered to

24

Public first but later it was made optional. SEBI made it necessary for merchant bank to
undertake or make a firm commitment for 5% of issued amount to the public.

12. Financial Engineering by Investment Bankers: - It involves design, development and

implementation of innovative financial instruments and processes and the formulation of creative
solutions to the problem in finance. A number of factors have accelerated the process of financial
innovation. They include

Interest rate volatility

Exchange rate volatility

Regulatory and tax changes

Globalization of the market

Increased competition among investment bankers

13. Securitization:- is a structured finance process, which involves pooling and repackaging of
cash-flow-producing financial assets into securities that are then sold to investors. The name
"securitization" is derived from the fact that the forms of financial instruments used to obtain
funds from the investors are securities. All assets can be securitized so long as they are associated
with cash flow. Hence, the securities which are the outcome of securitization processes are termed
asset-backed securities (ABS). From this perspective, securitization could also be defined as a
financial process leading to an issue of an ABS.
Securitization often utilizes a special purpose vehicle (SPV), alternatively known as
a special purpose entity (SPE) or special purpose company (SPC), in order to reduce the risk of
bankruptcy and thereby obtain lower interest rates from potential lenders. A credit derivative is
also generally used to change the credit quality of the underlying portfolio so that it will be
acceptable to the final investors.
A very basic example would be as follows. XYZ Bank loans 10 people $100,000 a piece,
which they will use to buy homes. XYZ has invested in the success and/or failure of those 10
home buyers- if the buyers make their payments and pay off the loans, XYZ makes a profit.
Looking at it another way, XYZ has taken the risk that some borrowers won't repay the loan. In
exchange for taking that risk, the borrowers pay XYZ interest on the money they borrow.
From the perspective of XYZ, those loans are 10 different assets. They have value- one, if the
loan fails, XYZ takes ownership of the house. Two, if the loan succeeds, XYZ gets their money
back along with the interest they charge. XYZ can do two things with those loans. They can hold
them for 30 years and, they would hope, make a profit on their investment. Or they could sell

25

them to some other investor, and walk away. In doing this, they would make less profit than if
they held onto them long term, but they would benefit in that they make some profit while also
getting their original investment back. They give up some of the reward (profit) in exchange for
not having the risk.
So XYZ Bank decides they'd rather have the cash now. They could sell those 10 loans to 10
investors. Each investor would be taking a risk in buying those loans, because if any loan
defaults, that one investor loses. Naturally, investors would not be willing to pay very much for
those loans, knowing the risk involved. XYZ wants to sell those loans for the best price they can
get, so they decide to securitize those loans. They combine the 10 loans into one entity, and then
they split that one entity into 10 equal shares. Each investor still pays the same $100,000, but
instead of owning one loan, they will own 10% of all 10 loans. If one loan fails, every investor
loses 10%.
The result is that XYZ bank is able to sell their assets for more money, and investors
are insulated from the volatility of directly owning individual mortgages. However, if a majority
of the mortgages in the asset pool act in the same way ( Correlation ) then the risk is similar to
owning one mortgage. Investors incur some of the volatility and there is no inherent "insurance"
against major loss.

Structure of Securitization
Pooling and transfer
The originator initially owns the assets engaged in the deal. This is typically a company
looking to raise capital, restructure debt or otherwise adjust its finances. Under traditional
corporate finance concepts, such a company would have three options to raise new capital: a loan,
bond issue, or issuance of stock. However, stock offerings dilute the ownership and control of the
company, while loan or bond financing is often prohibitively expensive due to the credit rating of
the company and the associated rise in interest rates.
A suitably large portfolio of assets is "pooled" and sold to a "special purpose vehicle" or "SPV"
(the issuer), a tax-exempt company or trust formed for the specific purpose of funding the assets.
Once the assets are transferred to the issuer, there is normally no recourse to the originator. The
issuer is "bankruptcy remote," meaning that if the originator goes into bankruptcy, the assets of
the issuer will not be distributed to the creditors of the originator. In order to achieve this, the
governing documents of the issuer restrict its activities to only those necessary to complete the
issuance of securities.

26

Since the structural issues is very complex, an investment bank facilitate (the arranger) the
originator in setting up the structure of the transaction.

Issuance
To be able to buy the assets from the originator, the issuer SPV issues tradable securities
to fund the purchase. Investors purchase the securities, either through a private offering (targeting
institutional investors) or on the open market. The performance of the securities is then directly
linked to the performance of the assets. Credit rating agencies rate the securities which are issued
in order to provide an external perspective on the liabilities being created and help the investor
make a more informed decision.
In transactions with static assets, a depositor will assemble the underlying collateral, help
structure the securities and work with the financial markets in order to sell the securities to
investors. The depositor typically owns 100% of the beneficial interest in the issuing entity and is
usually the parent or a wholly owned subsidiary of the parent which initiates the transaction. In
transactions with managed (traded) assets, asset managers assemble the underlying collateral,
help structure the securities and work with the financial markets in order to sell the securities to
investors. Some deals may include a third-party guarantor which provides guarantees or partial
guarantees for the assets, the principal and the interest payments, for a fee.
The securities can be issued with either a fixed interest rate or a floating rate. Fixed rate set the
coupon (rate) at the time of issuance, in a fashion similar to corporate bonds. Floating rate
securities may be backed by both amortizing and non amortizing assets. In contrast to fixed rate
securities, the rates on floaters will periodically adjust up or down according to a designated
index such as a U.S. Treasury rate, or, more typically, the London Interbank Offered Rate
(LIBOR). The floating rate usually reflects the movement in the index plus an additional fixed
margin to cover the added risk.

Credit enhancement and tranching

Unlike conventional corporate bonds which are unsecured, securities generated in a securitization
deal are "credit enhanced," meaning their credit quality is increased above that of the originator's
unsecured debt or underlying asset pool. This increases the likelihood that the investors will

27

receive cash flows to which they are entitled, and thus causes the securities to have a higher credit
rating than the originator. Some securitizations use external credit enhancement provided by third
parties, such as surety bonds and parental guarantees (although this may introduce a conflict of
interest). Individual securities are often split into tranches, or categorized into varying degrees of
subordination. Each tranches has a different level of credit protection or risk exposure than
another: there is generally a senior (A) class of securities and one or more junior subordinated
(B, C, etc.) classes that function as protective layers for the A class. The senior classes
have first claim on the cash that the SPV receives, and the more junior classes only start receiving
repayment after the more senior classes have repaid. Because of the cascading effect between
classes, this arrangement is often referred to as a cash flow waterfall. In the event that the
underlying asset pool becomes insufficient to make payments on the securities (e.g. when loans
default within a portfolio of loan claims), the loss is absorbed first by the subordinated tranches,
and the upper-level tranches remain unaffected until the losses exceed the entire amount of the
subordinated tranches. The senior securities are typically AAA rated, signifying a lower risk,
while the lower-credit quality subordinated classes receive a lower credit rating, signifying a
higher risk.
The most junior class (often called the equity class) is the most exposed to payment risk. In some
cases, this is a special type of instrument which is retained by the originator as a potential profit
flow. In some cases the equity class receives no coupon (either fixed or floating), but only the
residual cash flow (if any) after all the other classes have been paid.
Credit enhancements affect credit risk by providing more or less protection to promised cash
flows for a security. Additional protection can help a security achieve a higher rating, lower
protection can help create new securities with differently desired risks, and these differential
protections can help place a security on more attractive terms.
In addition to subordination, credit may be enhanced through

A reserve or spread account, in which funds remaining after expenses such as principal
and interest payments, charge-offs and other fees have been paid-off are accumulated,
and can be used when SPE expenses are greater than its income.

Third-party insurance, or guarantees of principal and interest payments on the securities.

Over-collateralization, usually by using finance income to pay off principal on some

securities before principal on the corresponding share of collateral is collected.

28

Cash funding or a cash collateral account, generally consisting of short-term, highly rated
investments purchased either from the seller's own funds, or from funds borrowed from
third parties that can be used to make up shortfalls in promised cash flows.

A third-party letter of credit or corporate guarantee.

A back-up servicer for the loans.

Discounted receivables for the pool.

Servicing
A servicer collects payments and monitors the assets that are the crux of the structured financial
deal. The servicer can often be the originator, because the servicer needs very similar expertise to
the originator and would want to ensure that loan repayments are paid to the Special Purpose
Vehicle. The servicer can significantly affect the cash flows to the investors because it controls
the collection policy, which influences the proceeds collected, the charge-offs and the recoveries
on the loans. Any income remaining after payments and expenses is usually accumulated to some
extent in a reserve or spread account, and any further excess is returned to the seller. Bond rating
agencies publish ratings of asset-backed securities based on the performance of the collateral
pool, the credit enhancements and the probability of default.
When the issuer is structured as a trust, the trustee is a vital part of the deal as the
gate-keeper of the assets that are being held in the issuer. Even though the trustee is part of the
SPV, which is typically wholly owned by the Originator, the trustee has a fiduciary duty to protect
the assets and those who own the assets, typically the investors.

Repayment structures
Unlike corporate bonds, most securitizations are amortized, meaning that the principal amount
borrowed is paid back gradually over the specified term of the loan, rather than in one lump sum
at the maturity of the loan. Fully amortizing securitizations are generally collateralized by fully
amortizing assets such as home equity loans, auto loans, and student loans. Prepayment
uncertainty is an important concern with full amortization. The possible rate of prepayment varies
widely with the type of underlying asset pool; so many prepayment models have been developed
in an attempt to define common prepayment activity.

29

A controlled amortization structure is a method of providing investors with a more

predictable repayment schedule, even though the underlying assets may be non-amortizing. After
a predetermined revolving period, during which only interest payments are made, these
securitizations attempt to return principal to investors in a series of defined periodic payments,
usually within a year. An early amortization event is the risk of the debt being retired early.
On the other hand, bullet or slug structures return the principal to investors in a single payment.
The most common bullet structure is called the soft bullet, meaning that the final bullet payment
is not guaranteed on the expected maturity date; however, the majority of these securitizations are
paid on time. The second type of bullet structure is the hard bullet, which guarantees that the
principal will be paid on the expected maturity date. Hard bullet structures are less common for
two reasons: investors are comfortable with soft bullet structures, and they are reluctant to accept
the lower yields of hard bullet securities in exchange for a guarantee.
Securitizations are often structured as a sequential pay bond, paid off in a sequential manner
based on maturity. This means that the first tranche, which may have a one-year average life, will
receive all principal payments until it is retired; then the second tranche begins to receive
principal, and so forth. Pro rata bond structures pay each tranche a proportionate share of
principal throughout the life of the security.

Structural Risks and Mis-incentives

Originators (e.g. of mortgages) have less incentive towards credit quality and greater incentive
towards loan volume since they do not bear the long-term risk of the assets they have created and
may simply profit by the fees associated with origination and securitization.

14. Portfolio management services:- A list of all those services and facilities that are
provided by a portfolio manager to its clients, relating to the management and administration of
portfolio of securities or the funds of clients, is referred to as portfolio management services.
The term portfolio means the total holdings of securities belonging to any person.
Portfolio Manager: - According to SEBI, Portfolio Manager means any person who pursuant to
contract or arrangements with a clients, advices or directs or undertakes on behalf of the clients
the management or administration of a portfolio of securities or the funds of client, as the case
may be
Discretionary Portfolio Manager:- According to SEBI, discretionary portfolio manager means a
portfolio manager who exercises or may, under a contract relating to portfolio management,

30

exercises any degree of discretion as to the investments or management of the portfolio of

securities or the funds of the clients, as the case may be.

FUNCTIONS
The objective of portfolio management is to develop a portfolio that has maximum
return at whatever level of risk the investor deems appropriate.
(A) Risk Diversification - An essential function of portfolio management is spread risk akin to
investment of assets. Diversification could take place across different securities and across
different industries. Diversification achieved in different industries is an effective way of
diversifying the risk in an investment. Simple diversification reduces risk within categories of
stocks that all have the same quality rating. The portfolio managers could as well adopt the
Markotiwz model whereby portfolio risk are sought to be reduced through combining assets,
which are less than perfectly positively correlated.
(B) Efficient Portfolio: -A portfolio manager aims at building dominant investment called
efficient portfolio. An efficient portfolio consists of combination of assets that maximizes return
and maximizes the risk level of expected return. The objective of portfolio management is to
analyze different individual assets and delineate efficient portfolios. A group of portfolio of
efficient portfolios is called efficient set of portfolios. The efficient set of portfolio comprises
efficient frontier.
(C) Asset allocation: - An important function of portfolio management is asset allocation. It deals
with attaining proportion of investments from categories. Portfolio managers basically aim at
stock-bond mix. For this purpose equally weighted categories of assets are used.
(D) Beta Estimation: - Another important function of a portfolio manger is to make an estimate of
beta coefficient. It measures and ranks the systematic risk of different assets. Beta coefficient is
an index of the systematic risk. This is useful in making ultimate selection of securities for
investment by portfolio manager.
(E) Rebalancing Portfolios: - Rebalancing of portfolio involves the process of periodically
adjusting the portfolios to maintain the original conditions of portfolio. The adjustments may be
made either by way of constant proportion portfolio or by way of constant beta portfolio. In
constant proportion portfolio, adjustments are made in such a way as to maintain the relative
weighting in portfolio components according to the change in prices. Under the constant beta
portfolio, adjustments are made to accommodate the values of component betas in the portfolio.

31

STRATEGIES
A Portfolio manager may adopt any of the following strategies as part of an efficient
management:
(A) Buy and Hold Strategy: - Under the buy and hold strategy, the portfolio manager builds a
portfolio of stock, which is not disturbed at all for a long period of time. This practice is
common in case of perpetual securities such as common stock.
(B) Indexing: - Another strategy employed by portfolio managers is indexing. Indexing involves
an attempt to replicate the investment characteristics of a popular measure of the bond
market. Securities that are held in best-known bond indexes are basically high-grade issues.

(C) Laddered Portfolio: - Under the laddered portfolio, bonds are selected in such a way that
their maturities are spread uniformly over a long period of time. This way a portfolio
manager aims at distributing the funds throughout the yield curve.
(D) Barbell Portfolio: - under this portfolio strategy, less investment of funds is made in middle
maturities.

15. Sales & Trading: - Make trades in securities for the primary and secondary markets
For currencies, stocks, bonds, derivatives, futures, commodities, asset-backed treasuries etc on
Behalf of institutional clients (mutual and pension funds), individual investors and for the
Banks themselves. Sales are another core component of any investment bank. Salespeople take
the form of:
1) The classic retail broker
2) The institutional salesperson, or
3) The private client service representative.
Brokers develop relationships with individual investors and sell stocks and stock advice to the
average Joe. Institutional salespeople develop business relationships with large institutional
investors. Institutional investors are those who manage large groups of assets, for example
pension funds or mutual funds. Private Client Service (PCS) representatives lie somewhere
between retail brokers and institutional salespeople, providing brokerage and money management
services for extremely wealthy individuals. Salespeople make money through commissions on
trades made through their firms.

32

In trading traders also provide a vital role for the investment bank. Traders facilitate the
buying and selling of stock, bonds, or other securities such as currencies, either by carrying an
inventory of securities for sale or by executing a given trade for a client. Traders deal with
transactions large and small and provide liquidity (the ability to buy and sell securities) for the
market. (This is often called making a market.) Traders make money by purchasing securities and
selling them at a slightly higher price. This price differential is called the "bid-ask spread.

SEBI Guidelines
The Government has setup Securities Exchange Board of India
(SEBI) in April 1988. For more then three years, it had no statutory powers. Its
interim functions during the period were:
i.

To collect information and advise the Government on matters relating to Stock and
Capital Markets.

ii.

Licensing and regulatory and Merchant Banks, Mutual Fund, etc.

iii.

To prepare the legal drafts for regulatory and developmental role of SEBI and

iv.

To perform any other functions as may be entrusted to it by Government.

The need for setting up independent Government agency to regulate and develop the Stock and
Capital Market in India as in many developed countries was recognized since the Seventh Five
Year was launched (1985) when some major industrial policy changes like opening up of the
economy to out side the world and greater role to the Private Sector were initiated. The rampant
malpractices noticed in the Stock and Capital Markets stood in the way of infusing confidence of
investors, which is necessary for mobilization of large quantity of funds from the public, and help
the growth of the industry. The malpractices were noticed in the case of companies, Merchant
Bankers and Brokers who are all operating in Capital Markets. The security industry in India has
to develop on the right lines for which a competent Government agency as in UK (SIB) or in
USA (SEC) is needed.
A few examples of malpractices in the primary market are as follows:
a) Too may self styled Investment Advisers and Consultants.
b) Grey Market or unofficial premiums on the new issues.

33

c) Manipulation of markets before new issues is floated.

d) Delay in allotment letters or refund orders or in dispatch of Share Certificates
e) Delay in listing and commencement of trading in shares.
A few examples of malpractices in the Secondary Market are as fallows:
a) Lack of transparency in the trading operations and prices charged to clients.
b) Poor service due to delay in passing contract notes or not passing contracts notes, at all.
c) Delay in making payments to clients or in giving delivery of shares.
d) Persistence of odd lots and refusal of companies to stop this practice of allotting shares in
odd lots, which disappeared with the introduction of D-mat form of trading.
e) Insider trading by agents of companies or brokers rigging and manipulating prices.
f) Takeover bids to de-stabilize management.

Objectives of SEBI
The SEBI has been entrusted with both the regulatory and development function.
The objectives of SEBI are as follows:a)

Investor protection, so that there is a steady flow of savings into the Capital
Markets.

b) Ensuring the fair practices by the issuers of securities, namely, companies so that

they can raise resources at least cost.

c)

Promotion of efficient services by brokers, merchant bankers and others

intermediaries so that they become competitive and professional .

SEBI POWERS
The SEBI powers on stock exchanges and their member brokers and sub brokers were exercised
under SEBI (stock brokers and sub brokers) Regulations of October 23 1992. These relate to
registration, licensing, code of conduct, and inspection of books accounts, etc. These powers were
exercised under Section 12 of SEBI Act.
SEBI was delegated more powers of administration of SC (R) Act in respect of many
provisions including recognition of stocks exchanges (Sec.3, 4&5) and control and regulation of
stocks exchanges under Sections 7, 13, 18, 22 and 28 etc., These were concurrent powers wielded
by both Government and SEBI, effective from September1993.
Subsequently, by an ordinance in January 1995, the SEBI was given further powers to
impose penalties on insider trading and capital markets intermediaries for violation of SEBI

34

regulations and companies for not complying with listing agreement. In particular penalties can
be imposed in monetary terms, for failure to furnish books of accounts, failure to enter into
agreements with clients, failure to redress investor grievances, defaults in case of mutual funds,
and non-disclosures of acquisition of shares and take over etc.
Venture capital funds like mutual funds were brought under the control of SEBI. Earlier
to that, the SEBI has started licensing and regulations the underwriters, debenture trustees,
collecting bankers, and all intermediaries in the capital market.
SEBI in the New Millennium:
SEBI has got all the needed powers to regulate the Capital Market including all affairs of
listed Companies, Venture Funds, MFs, etc. Already it has been regulating the foreign
agencies or a body operating in the capital market and it has announced guidelines for all
players in markets, including a code of conduct.

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) MERCHANT

BANKING -ROLE & FUNCTIONS

(a) Authorization
Any person or body proposing to engage in the business of Merchant Banking would
need authorization by SEBI in the prescribed format. This will apply to those presently
engaged in the Merchant Banking activity, including as Manager, Consultants or Advisers
to issues.
(b) Authorized Activity
(i) Issue Management

(ii) Corporate Advisory services relating to the issue

(iii) Underwriting
(iv) Portfolio Management Services (PMS)
(v) Managers, Consultants or Advisers to the issue
(c) Authorization Criteria
All Merchant Bankers are expected to perform with high standards of integrity and
fairness in all their dealings. A code of conduct for the Merchant Bankers is prescribed
by SEBI which will take into account the following:
(i) Professional Competence
(ii) Personnel, their adequacy and quality and other infrastructure

35

(iii) Capital Adequacy

(iv) Past track record, experience, general reputation and fairness in all their
transactions.
(d) Terms of Authorization
(i) All Merchant bankers shall have a minimum net worth of Rs.5crore.
(ii) The Authorization will be for an initial period of 3 years.
(iii) All issues should be managed by at least one authorized to Merchant banker
functioning as the Lead Manager or sole Manager.
Issue Amount
Up to Rs.50crores
Over Rs. 50crores not
more than Rs.100crores
Over Rs.100crores

No. of Lead
Not
Not
Not

Managers
More than 2
More than 3
More than 4

(iv) The Merchant Bankers shall exercise due diligences independently verifying the
contents of the prospectus. The Merchant Bankers of the issues shall certify to this
effect to SEBI.
(v) In respect of issues managed by the Merchant Bankers, they would be required to
a minimum 5% underwriting obligation for issue subject to a ceiling of Rs.25lakh.
(vi) The merchant bankers involvement will continue till the complete on of essential
to follow-up steps including listing of the shares and dispatch of certificates.
(vii) The Merchant Banker shall make available to SEBI such information, returns and
reports as may be called for.
(viii) Merchant Bankers shall adhere to the code of conduct which shall prepared by
SEBI.
(ix) Merchant Bankers to ensure that Publicity / Advertisement material accompanying
the application form to the issue meets the requirement of GOI/SEBI.
(x) SEBI shall be informed well before the opening of the issue the Inter allocation of
activities/sub-activities, among lead managers to the issue.
(xi) Merchant Bankers performing or planning to perform portfolio management services
shall furnish the details in the prescribed format.

(f)

Grading of Prospectus
Grading of Prospectus will be done by SEBI using the following parameters:(i) Objective description of the project, its status and implementation.
(ii) Track record of the promoters and their competence.
(iii) Disclosure about Demand - Supply position, Market and Marketing

36

arrangements, Raw materials availability and infrastructural facility.

(iv) Objective assessment of Business prospects and profitability.

(g) Penalty Point System

SEBI has introduced penalty point system for Merchant Bankers who fail to comply
with the various provisions. The areas of non-compliance/defaults have been categorized
into following four categories. The activities are classified within these four categories:
Type

Nature

Penalty points

II
II
III
IV

General defaults
Minor defaults
Major defaults
Serious defaults

1
2
3
4

Commercial banking vs. investment banking

While regulation has changed the businesses in which commercial and investment banks may
now participate, the core aspects of these different businesses remain intact. In other words, the
difference between how a typical investment bank and a typical commercial operate bank is
simple. A commercial bank takes deposits for checking and savings accounts from consumers
while an investment bank does not. We'll begin examining what this means by taking a look at
what commercial banks do.

Commercial banks
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 Federal
Deposit Insurance Corporation (the FDIC), on amounts up to $100,000. To get FDIC guarantees,
commercial banks must follow a myriad of regulations. The typical commercial banking process
is fairly straightforward. You deposit money into your bank, and the bank loans that money to
consumers and companies in need of capital (cash). You borrow to buy a house,
Finance a car, or finance an addition to your home. Companies borrow to finance the growth of
their company or meet immediate cash needs. Companies that borrow from commercial banks
can range in size from the dry cleaner on the corner to a multinational conglomerate.
Investment banks

37

An investment bank operates differently. 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 does not, an I-bank must spend
considerable time finding investors in order to obtain capital for its client.

Structural analysis of investment banking industry

Every industry functions in an environment, which to a great extent determines the strategies to
be adopted by it for survival. The term environment includes both internal as well as external
factors, such as the level of competition within the industry, the level of technology used,
government policy, etc., which could affect its ability to function effectively. These forces and the
interplay amongst them constitute the structure of the industry.
Five forces which determine collectively the profit potential of the industry and are measured in
terms of the long run return on invested capital are:
1. Threat of entry

38

2. competition
3. pressure from substitute
4. bargaining power of buyers
5. bargaining power of suppliers
1. Threat of entry - new entrant into the industry may pose a threat to the existing players.
Major threats to entry into industry depend on:

Economies of scale

Product differentiation

Capital requirement

Switching cost

Access to distribution channels

Government policy

Relationship with customers

Efficiency of employees

2. Competition: - competition based on factors such as prices, advertising, goodwill, product

innovations, customer services, after sales services, etc., also act as major entry barrier to
new firms. A unique feature of this industry is the extent of ties among the investment
banks themselves. They share customers, work together, jointly underwrites deals, and
negotiate with each other in M&Q transaction. However the investment banks compete for
business from the same customer . In India, only 25% of the investment bankers are active
in issue management while rests are involved in underwriting. The smaller Investment
bankers usually take care issue of low size. Low entry barriers into the Industry have led to
the mushrooming of investment banking outfit in India
3. Pressure from substitute products: - substitute products to issue management may be
new innovations in the methods of raising funds. For instance, companies might prefer
privately placing the issue instead of a public offering.
Previously all the public issues were routed through regional stock exchanges.
But with establishment of OTC in India in the year 1990 with a facility for screen based
automated computerized trading system, it has acted as a substitute to smaller public
issues. In OTCEI, sponsor place the scrips with member of OTC whom will in turn offload
the scrips to public thus reducing the issue cost. So establishment of such exchanges like
NSE and OTCEI also will act as substitute to other stock exchanges .

39

4. Bargaining power of buyers: - here customers of investment bankers mainly promoters

on one side and investors on the other side. The main job of investment bankers is to act as an
intermediary between these two sides. In designing new instrument or executing the public
issue it has to keep in mind the requirement of promoters as well as of the investors. The
successes of an investment bankers or reputation of investment bankers depends on the
success of the issue. So the most important attribute of investment bankers is to have good
expertise in its field of specialization and the ability to know the pulse of market
5. Bargaining power of suppliers: - investment banking industry being a service industry, no
definite suppliers can be identified as skills of professional are utilized in the process. But
persons, who support the investment banker in successful execution of the issue like registrar,
printers, advertiser, underwriters, bankers, legal advisors, etc., can be considered as suppliers
because their co-operation and support the public issue cannot see light. People rendering
services these services are in large number in the market, hence bargaining power of suppliers
can be considered to be very less. Finally success of Investment banking depends on the
relationship with clients, image of the firms and quality of services offered.

Risk involved in investment banking

In the course of their operations, investment banks are invariably faced with different types of
risks that may have a potentially negative effect on their business. Risk management in
investment bank operations includes risk identification, measurement and assessment, and its
objective is to minimize negative effects risks can have on the financial result and capital of a
bank. Investment banks are therefore required to form a special organizational unit in charge of
risk management. Also, they are required to prescribe procedures for risk identification,
measurement and assessment, as well as procedures for risk management.
The risks to which a investment bank is particularly exposed in its operations are: liquidity risk,
credit risk, market risks (interest rate risk, foreign exchange risk and risk from change in market
price of securities, financial derivatives and commodities), exposure risks, investment risks, risks
relating to the country of origin of the entity to which a bank is exposed, operational risk, legal
risk, reputational risk and strategic risk.

Liquidity risk - is the risk of negative effects on the financial result and capital of the
bank caused by the banks inability to meet all its due obligations .

Credit risk - is the risk of negative effects on the financial result and capital of the bank
caused by borrowers default on its obligations to the bank.

40

Market risk - includes interest rate and foreign exchange risk .

1. Interest rate risk - is the risk of negative effects on the financial result and capital of the
bank caused by changes in interest rates.
2. Foreign exchange risk - is the risk of negative effects on the financial result and capital
of the bank caused by changes in exchange rates.
A special type of market risk is the risk of change in the market price of securities,
financial derivatives or commodities traded or tradable in the market.

Exposure risks - include risks of banks exposure to a single entity or a group of related
entities, and risks of banks exposure to a single entity related with the bank.

Investment risks - include risks of banks investments in entities that are not entities in
the financial sector and in fixed assets.

Risks relating to the country of origin of the entity to which a bank is exposed (country risk) is the risk of negative effects on the financial result and capital of the bank
due to banks inability to collect claims from such entity for reasons arising from
political, economic or social conditions in such entitys country of origin. Country risk
includes political and economic risk, and transfer risk.

Operational risk - is the risk of negative effects on the financial result and capital of the
bank caused by omissions in the work of employees, inadequate internal procedures and
processes, inadequate management of information and other systems, and unforeseeable
external events.

Legal risk it is the risk of loss caused by penalties or sanctions originating from court
disputes due to breach of contractual and legal obligations, and penalties and sanctions
pronounced by a regulatory body.

Reputational risk - is the risk of loss caused by a negative impact on the market
positioning of the bank.

Strategic risk - is the risk of loss caused by a lack of a long-term development

component in the banks managing team.

Need for risk management

41

The primary goal of risk management is to ensure that a financial institutions trading, position
taking, credit extension, and operational activities do not expose it losses that could threaten the
viability of the firm. As risk taking is an integral Part of the investment banking business, it is not
surprising that investment bank have been risk management ever since they have been
established. The only thing which has change is the complexity.
It involves following steps

Identifying and assessing risks

Establishing policies, procedures, and risk limits

Monitoring and reporting compliance with reliance with these limits

Delineating capital allocation and portfolio management

Developing guidelines for new products and including new exposures within the current
frame work

Applying new measurements methods to the existing product

Risk management practices in front office

1. Taping of telephone lines of traders and dealers to resolve of disputes at a later date.
2. Restriction on personal trading by the dealer.
3. Restrictions on transaction at off market rates and documentation procedures to justify any
off-market transactions.

4. Restrictions on after-hours trading and off-premises trading and documentation procedures

to justify them when undertaken.
5. Adequate compensation policies should be formulated to protect dealers from losses in case
of disputed traders.
6. Revaluation of position may be conducted by traders to monitor positions by the controllers
to record periodic profit and loss, and by the risk mangers who seek to estimate risk under
various market conditions.
7. Traders should maintain professionalism, confidentiality and proper language in telephone
and electronic conversation.
8. Management should analyze the trading activity periodically.
Risk management in the back office

42

1. It should have written documentation indicating the range of permissible products,

trading authorities and permissible counterparties.
2. It should have limits for each type of contract or risk type.
3. The management should explicitly state the procedure for the written authorization of the
trades in excess of the laid down limits.
4. Adequate procedure for promptly resolving the failure to receive or deliver securities on
the settlement dates must be established.
Other risk management practices
1. As with traditional banki9ng transactions, an independent credit function should conduct
an internal credit review before engaging in transaction with the prospective
counterparties. Credit guidelines should ensure that the limits are approved for only those
counterparties that meet the appropriate credit criteria. The credit risk management
function should verify that the limits are approved by the credit specialist.
2. The assessment of the counterparties based on simple balance sheet measures the
traditional assessment of the financial condition may be adequate for many types of
counterparties. The credit risk assessment policies should also properly define the type of
analysis to be conducted on the counterparties based on the nature of their risk profile. In
some instance stress testing may be needed when counterpartys creditworthiness may be
adversely affected by the short-term fluctuations in the financial markets.
3. The top management has to identify those areas where the bank practices may not comply
with the stated policies. Necessary internal controls for ensuring that the practices
confirm with that stated policies should be put in place.

Type of Expertise Required

Investment banking is one of the best ways a young person can learn about finance and make
good money right out of school. It requires substantial hardships, including high pressure, long
days and nights of hard work, a few difficult personalities, and the expectationno, the
requirement that all personal plans are subject to the demands of work. Life is very much at the
mercy of the markets. Bull markets bring more work to do than is humanly possible. The type of
staff required for a merchant bank will depend upon its functions which are them selves flexible.
The merchant bank should have an organization large enough to deal with a number of
applications at a time. The issue house which acts as the merchant banker normally pays visits to
the company's plant, warehouses, and other physical assets and if a company is making its first
issue, it might secure independent reports from Chartered Accountants, industrial consultants,

43

technical experts etc. The issue house, which is a merchant bank also, requires, plant,
management, labor, competitors, profit margins, taxations, etc. They have to keep ready all the
information needed in the form of dossiers with respect to the affairs of the company generally
enquired into by the investing public, lending financial institutions and the government.
Secondly, a merchant bank has to suggest an appropriate time of issue and provisional
terms. Once these terms are settled the share certificates, prospectus and other
documents are drafted by the merchant bank with the assistance of lawyers, accountants
and others. They have to satisfy the Companies Act and other SS requirements of law.
Subsequently, the merchant bank may have to get ready the application to the SEBI for
the public issues. This requires familiarity with the regulations under the Companies Act
and the SEBI guidelines and the procedures to be followed and the authorities to be
approached. The provisions under the MRTP Act regulating monopoly practices and
other activities of big industrial houses should also be looked into.
Thirdly, they may have to make an application to the appropriate stock exchange for
quotation and satisfy the stock exchange authorities with respect to the terms of issue and
prospectus. Listing requirements are to be observed and familiarity with the stock
exchange rules and bye-laws as well as the provisions of the Securities Contracts
Regulations) Act would be essential. They may have to advise on the desirability or
otherwise of listing on the stock exchange as well as help the companies go through the
process of getting their shares listed. Advertisements containing all the information
legally required to be given in the prospectus must be published in all the leading
proposed date of opening and closing, a summary of the companys business history,
balance sheet, etc, to which a reference was made earlier. Once the issue made, the work
of the merchant bank relates to arranging for the allotment of shares in consultation with
the company and the stock exchange authorities with the help of Registrars.

Possible conflicts of interest

It is crucial to note whether an investment bank has provided corporate finance services to the
company under coverage. Usually at the end of a research piece, a footnote will indicate whether
this is the case. If so, investors should be careful to understand the inherent conflict of interest
and bias that the research report contains. Often covering a company's stock (and covering it with
optimistic ratings) will ensure corporate finance business, such as a manager role in equity
offerings, M&A advisory services, and so on. Potential conflicts of interest may arise between
different parts of a bank, creating the potential for financial movements that could be market
manipulation. Authorities that regulate investment banking (the FSA in the United Kingdom and

44

the SEC in the United States) require that banks impose a Chinese wall which prohibits
communication between investment banking on one side and research and equities on the other .
Some of the conflicts of interest that can be found in investment banking are listed here:

Historically, equity research firms were founded and owned by investment banks. One
common practice is for equity analysts to initiate coverage on a company in order to
develop relationships that lead to highly profitable investment banking business. In the
1990s, many equity researchers allegedly traded positive stock ratings directly for
investment banking business. On the flip side of the coin: companies would threaten to
divert investment banking business to competitors unless their stock was rated favorably.
Politicians acted to pass laws to criminalize such acts. Increased pressure from regulators
and a series of lawsuits, settlements, and prosecutions curbed this business to a large
extent following the 2001 stock market tumble

Many investment banks also own retail brokerages. Also during the 1990s, some retail
brokerages sold consumers securities which did not meet their stated risk profile. This
behavior may have led to investment banking business or even sales of surplus shares
during a public offering to keep public perception of the stock favorable.

Since investment banks engage heavily in trading for their own account, there is always
the temptation or possibility that they might engage in some form of front running.

The Big Picture- Major Players in investment banking

Until the wave of consolidation and convergence that started in the 1990s in the financial services
industry, the playing field had changed very little and was easy to understand. Commercial banks
and investment banks each had their roles, as defined by federal regulations, and seldom did the
two meet. And within investment banking, firms could be neatly categorized by their size, market
focus, or both. At the top was the bulge bracket, which consisted of the six largest firms: Merrill
Lynch, Goldman Sachs, Morgan Stanley, Salomon Smith Barney, First Boston, and Lehman
Brothers. These firms still dominate the securities underwriting and M&A markets, though there
are few name changes in the past few years. All firms beyond the bulge bracket were labeled
boutiques or regional. Boutiques are niche firms that focus on a particular industry, such as

45

technology, or financing vehicle. Regional, as the name implies, focus on financing and
investment services in a particular geographic region. These labels are still used (although the
smaller firms scorn the boutique image), but as the rapid pace of mergers and acquisitions
continues to alter the landscape, the traditional categories are becoming less and less meaningful.
Large commercial banks that have acquired investment banks are bringing large amounts of
capital to the playing field, along with a mix of financial services more varied than ever before.
Some of the major players on investment banking are:
1.

Bank of America Securities LLC -Bank of America Securities is the U.S. investment
banking arm of Bank of America, one of the biggest commercial banks around. Together
with Bank of Americas U.K. investment banking subsidiary, Banc of America Securities
Ltd., it offers a full range of investment banking and brokerage services. The company
was created in 1998, when its parent bank acquired Montgomery Securities. Later, Bank
of America was acquired by NationsBank, and the combined entity took on the Bank of
America name. Banc of America Securities main offices are in San Francisco, New York,
and Charlotte. It employs people in areas including corporate and investment banking, the
global markets group (debt capital raising, sales, trading, and research), portfolio
management, e-commerce, global treasury services, and asset management. Banc of
America Securities offers full-time and summer associate and analyst programs in the
United States and in Europe.

2.

Credit Suisse first Boston LLC - Credit Suisse First Boston is the result of the 1988
merger of the investment bank First Boston and Credit Suisse, a European commercial
bank. In 2000, the firm acquired Donaldson, Lufkin & Jenrette, and a leading underwriter
of high-yield bonds with a golden reputation in research. A bulge-bracket bank, CSFB
ranked fifth among all banks in 2003 in terms of global debt, equity, and equity-related
issuance. CSFB has experienced trouble in recent years, with business slackening in key
areas (e.g., IPO underwriting) and regulatory trouble (the firm paid a $200 million fine in
2002 for research improprieties and another $100 million in 2002 to settle charges that it
received kickbacks in the form of higher commissions from clients to whom it allocated
hot IPO sharesand in the process rock-star tech banker Frank Quattrone resigned and
eventually was convicted of criminal charges). The firm has also been losing key bankers
in recent times; epitomizing this trend, the CEO of the investment bank, John Mack,
announced plans to leave the firm in the summer of 2004, reportedly due to the fact that
his desire to merge Credit Suisse with another firm was not in line with the desires of the
majority of the directors of Credit Suisse. After that announcement, the firms head in

46

China announced plans to leave the firm, and as this guide goes to press the firm must
surely be worried that an exodus of the firms talent in Asia will ensue.
3.

Deutsche Banc Securities Inc. - Deutsche Banc Securities is the full-service North
American investment banking arm of German financial services giant Deutsche Bank
AG. It includes Deutsche Bank Alex. Brown, which provides M&A, acquisition finance,
and project finance advisory to clients in the health-care, media, real estate, technology,
and telecom sectors. The bank has been undergoing some changes, with some key
employees leaving the firm and the addition of a number of senior-level hires. In March
2004, Deutsche announced it was laying-off 50 employees in the equity group, including
nine senior research analysts, dropping coverage of 100 of the 731 companies it used to
cover in the process. Observers report that layoffs could continue as the bank cuts back
on research coverage, a common trend on the Street. Overall, though, Deutsche Bank has
been focused on building its presence in North America.

4.

The Goldman Sachs Group, Inc. - Goldman Sachs was founded in 1869 when Marcus
Goldman, an immigrant from Europe, began a small enterprise to provide an alternative
to expensive bank credit. In the 1950s, Goldman played a lead role in establishing the
municipal bond market, and in the 1970s the firm formed the first official M&A and real
estate departments on Wall Street. Today it continues to sit at or near the top in most areas
of investment banking advisory, sales, and trading. In the first 6 months of 2004,
Goldman ranked second in global equity and equity-related business, second in global
IPO underwriting, fourth in global investment-grade corporate debt, fourth in
underwriting, and first in M&A advisory. Perhaps even more significant, it is probably
considered by the majority of people in the industry as the gold standard in terms of the
quality of its employees (a belief thats especially true among Goldman employees,
naturally), what an investment bank should be, and how a bank should do business. (A
fact thats a bit ironic given that Goldman has faced as much scrutiny as any other bank
as the SEC and other regulators try to clean up Wall Street in the wake of the early-2000s
banking scandalsand has had to pay a pretty penny to settle charges of misdeeds
brought against it.)

5.

J.P Morgan & Co. - This firm was formed by a mega-merger when Chase Manhattan,
one of the largest commercial banks around, paid $33 billion to join with J.P. Morgan,
one of the oldest and most prestigious commercial and investment banks in the world.
Subsidiaries include J.P. Morgan Fleming Asset Management, which serves institutional

47

investors; J.P. Morgan Partners, a private-equity house; J.P. Morgan H&Q, an investment
banking arm focused on areas like tech and health care; and J.P. Morgan Private Bank,
which serves wealthy private clients. And now, with the 2004 acquisition of Bank One,
its getting even bigger. (However, the acquisition probably wont have a major effect on
the way things are done in the investment bank, J.P. Morgan.) J.P. Morgan is a major
player in terms of debt and equity issuance worldwide; in the first half of 2004, it was
third in the league tables in global equity underwriting, in U.S. IPO underwriting, and in
overall debt underwriting. It is also a player in M&Afifth best in the business, in terms
of worldwide announced deals in the first half of 2004.
6.

Merill Lynch & Co., Inc. - Merrill was founded in 1914, when Charles Merrill opened
the first U.S. retail brokerage firm, winning his company the nickname the firm that
brought Wall Street to Main Street. He was joined a year later by his friend Edmund
Lynch. In recent years, the company has worked to increase its presence in the global
market place. The firms strength lays in its vast retail brokerage network and large asset
management business, as well as its position near the top of the global underwriting and
advisory league tables. All has not been rosy for Merrill of late. Poor performance has
forced the firm to drop thousands of employees over the past several years. In 2002, the
firm was forced to pay $100 million to New York State after evidence supporting
allegations of fraudulent stock recommendations by Merrill research analysts came to
light. Also in 2002, the firm was one of a number of major banks paying between $80
million and $125 million as part of a $1.335 billion settlement with regulators for
research misdeeds. In 2003, the firm was charged by the SEC with helping Enron
fraudulently pump up its profits in 1999, and Merrill agreed to pay $80 million to settle.

The Evolving industry structure

As the global economic climate cooled down following the economic and financial meltdown, so
did investment banking performance. Lower interest rates drive business, such as mortgagebacked and municipal securities. At the same time, the big banks found them selves tremendously
overstaffed, having hired new employees like gangbusters in the boom years of the 1990s. As a
result, investment banks have started laying-off.
Investment banking has witnessed a rash of cross-industry mergers and acquisitions in recent
times, largely due to the late-1999 repeal of the Depression-era Glass-Steagall Act. The repeal,
which marked the deregulation of the financial services industry, now allows commercial banks,

48

investment banks, insurers, and securities brokerages to offer one anothers services. As I-banks
add retail brokerage and lending to their offerings and commercial banks try to build up their
investment banking services, the industry is undergoing some serious global consolidation,
allowing clients to invest, save, and protect their money all under one roof. These mergers have
added a downward pressure on employment in the industry, as merged institutions make an effort
to reduce redundancy.
The Industry One of the biggest issues was the fact that banks overrated the investment
potential of client companies stocks intentionally, deceiving investors in the pursuit of favorable
relationshipsand ongoing banking revenue opportunitieswith those companies. Firms also
came under fire for the methods by which they allocated stock offerings (specifically, for whether
they charged excessive commissions to clients who wanted to purchase hot offerings), as well as
for possible manipulation of accounting rules in the course of presenting clients financial info to
potential investors. By now, almost all of the important investment banks have paid fines totaling
in the billions of dollars to settle allegations against them, and the scrutiny of regulators remains
sharp. And banks are paying millions to purchase independent research to provide to their
customers.
The Industry

Conclusion
For the past couple of years the investment banking industry has been shrinking and the current
scenario calls for combined efforts by the regulators and the industry itself to take measures for
improving the situation. At present the industry is going through changes. Many non banking
finance companies are focusing on becoming multi business entities so that they can remain
commercially viable. The corporate sector has perennial needs for services such as investment
advisory, corporate restructuring, distressed assets acquisition and equity and debt financing. And
as the economy improves the need for these services will further intensify. This indicates good

49

prospects for the investment banks proficient in these areas of business. It is time for the
investment banks to focus on developing competitive advantages in the form of wider outreach
and ability to mobilize national savings with greater efficiency.
In this scenario, investment banks have had to increase their international presence in order to
retain existing clients and to generate new business. They have been achieving these offices
abroad as well as by acquiring or merging with foreign investment banks. Similarly investment
banks from other countries have been strengthening their ties with American investment banks.
The industry has been witnessing consolidation across geographical functional-supermarket,
where all the financial need of all types of clients can be fulfilled. With the abolition of glassSteagell act, it is possible for bank to convert itself into a supermarket that offers all types of
financial services to issuers and investors, at both retail and wholesale level. The range of
services offered may cover underwriting services, fund, management, insurance products, credit
cards, loans, depository services. Corporate advisory services, trust services etc.
The rapid technology changes have started affecting the industry. As various commercial
banking and investment banking activities have become digitalized, the established players are
facing challenge on pricing front from all small new players. This is big forcing big banks to find
means of turning the digitalization to their advantage and reducing cost. Today they are focusing
more on lower cost, better quality services, innovative products and new service channel so that
can have deeper penetration in the market. During the downturn in the economy the demand for
the industries services declines equally fast. The earning in the industry are extremely volatile as
they depend upon extremely volatile factors like interest rates, exchange rates., inflation etc. they
need to stay big enough at all times to be able to satisfy suddenly increasing demand, yet be
flexible enough to be able to downsize quickly in a declining market.

Bibliography

Websites
1. www.google.com
2. www.wikipedia.org
3. www.pfoo.com

50

4. www.financeconnectsingapore.com

Books
1. Investment Banking(ICFAI)

51