Investment Banking
Overview
2. Investment banking
3. Trading
4. Asset management
1.
1
L9: Overview on Investment Banking
2
L9: Overview on Investment Banking
Overview
 The investment banking industry was transformed during
2008 when five large US pure-play/non-deposit taking firms
experienced the following events:
 Bear Stearns was sold to JP Morgan
 Lehman Brothers filed for Bankruptcy protection and then sold
its US operations to Barclays and European and Asian businesses
to Nomura
 Merrill Lynch was sold to Bank of America
 Goldman Sachs converted to a bank holding company
 Morgan Stanley converted to a bank holding company
3
L9: Overview on Investment Banking
Key Problems During 2008
•
Investment banks were over-reliant on short-term financing (>40% of total liabilities):
largely repurchase agreements (repos) and commercial paper (CP)
A repo provides financing when a bank sells securities and agrees to repurchasing them the next day or week
at a higher price (the buyer can sell securities in the market if the seller is unable to repurchase)
• CP is unsecured financing that has a maturity of up to 270 (most CP matures in 90 days)
•
4
•
Benefits of CP and repo funding (during normal markets) include: cheap, liquid, flexible and,
substantial earnings power in upward sloping yield environment when use to purchase long term
assets
•
Risks include: refinancing risk and asset/management liability mismatch, resulting in potential
bankruptcy threat if need to sell unfunded assets because can’t replace short-term funding
•
Investment banks were over-leveraged: total assets to equity leverage ratios were 26x at
Goldman Sachs; 31x at Lehman; 32x at Merrill Lynch; 33x at Morgan Stanley and 34x at Bear
Stearns
•
Investment banks suffered large mortgage securities related losses in their proprietary
trading, underwriting and asset management areas
L9: Overview on Investment Banking
New Landscape
 Following the 2008 transformation of the investment banking
industry, Goldman Sachs and Morgan Stanley operated based
on the same business model employed by larger universal
banks, including:
 Leverage dropped from 30x to 12x
 Return on equity dropped from >25% to <15%
 Short term borrowings from repos and CP significantly reduced
 Risk based capital increased
 Proprietary and principal investment activities reduced
 Additional regulatory controls imposed
 Access to discount window and FDIC guarantees
5
L9: Overview on Investment Banking
6
L9: Overview on Investment Banking
7
L9: Overview on Investment Banking
8
L9: Overview on Investment Banking
Investment Banking Division
9
L9: Overview on Investment Banking
Investment Banking Division
10
L9: Overview on Investment Banking
Investment Banking Division
11
L9: Overview on Investment Banking
Investment Banking Division
12
L9: Overview on Investment Banking
Investment Banking Division
13
L9: Overview on Investment Banking
Trading Division
 Fixed Income, Currencies and Commodities (FICC) Business
 Government Bonds, corporate bonds, mortgage-related
securities, asset-backed securities
 Commodities and foreign exchange
 Equities Business
 Common stock
 Convertible securities
14
L9: Overview on Investment Banking
Trading Division
 Responsible for all investment-related transactions with





15
institutional investors, including financial institutions,
investment funds and cash management arms of governments
and corporations
Make markets and clear on exchanges
Responsible for principal investments for the firm’s own
account (usually in partnership with the Banking Division)
Trade derivatives as well as underlying (cash) securities
Engage in proprietary trading
Provide research to investing clients
L9: Overview on Investment Banking
Trading Division
 Client Related Trading
 Help investing clients make money while the firm also achieves
trading profits
 Primary and secondary market trading activity
 Proprietary Trading (for the firm’s own account)
 Similar to the trading activities of hedge funds
 Financial reform legislation will likely reduce proprietary
trading over time
16
L9: Overview on Investment Banking
Asset Management Division
17
L9: Overview on Investment Banking
Asset Management Division
 Asset Managers manage money for clients brought in my Private




18
Wealth (PW) advisors
PW advisors help investing clients allocate investment funds
Asset Managers receive fees from managing money and then share
these fees with PW advisors
Asset Managers and PW advisors at investment banks compete
with other large money managers such as Fidelity and Putnam,
and with hedge funds and private equity funds
Asset Managers manage stock, bond, FX, commodity and real
estate funds, as well as funds focused on hedge fund and private
equity fund-type investments
L9: Overview on Investment Banking