Overview of the Financial
Industry
Last Edited: October 4th, 2013
S
Overview of the Financial Industry
Purpose of the Financial Industry
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■ Companies need funds in order to purchase capital goods (real
estate, buildings, machines, etc.), inventories, and pay for
labor. They also need money to fund acquisitions
■ There are two main ways that companies can raise money
from the public markets: equity and debt
■ Usually, new companies, being relatively unknown, cannot
simply sell shares or issue bonds on their owe
■ They usually hire an investment bank to run the issue for them
■ Quick Summary:
- The stock and bond markets
- The structure and roles of an investment bank
-
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Overview of the Financial Industry
The Equity Market
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What is Stock?
A type of security that signifies ownership in a corporation and represents a
claim on part of the corporation's assets and earnings.
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Why do corportations issue stock?
Corporations raise capital by issuing stocks and entitle the stock owners
(shareholders) to partial ownership of the corporation. Stocks are bought and
sold on what is called an exchange. There are several types of stocks and the
two most typical forms are preferred and common stock.
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Market capitalization (or market cap)
Total value of the issued shares of a publicly traded company; it is equal to the
share price times the number of shares outstanding. Capitalization could be
used as a proxy for the public opinion of a company's net worth and is a
determining factor in some forms of stock valuation.
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IPO
An initial public offering (IPO) or stock market launch is a type of public offering
where shares of stock in a company are sold to the general public, on a
securities exchange, for the first time. Through this process, a private company
transforms into a public company.
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Overview of the Financial Industry
The Equity Market
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The S&P 500, or the Standard & Poor's 500, is a stock
market index based on the market capitalizations of 500 large
companies whose common stock is publicly traded on the
NYSE (The New York Stock Exchange).
•
It is a tool used by investors and financial managers to
describe the market, and to compare the return on specific
investments.
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Overview of the Financial Industry
The Equity Market
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Overview of the Financial Industry
The Bond Market
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■ What is bond?
A bond is an instrument of indebtedness of the bond issuer to the holders. It is a
debt security, under which the issuer owes the holders a debt and, depending on
the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay
the principal at a later date, termed the maturity. Interest is usually payable at fixed
intervals (semiannual, annual, sometimes monthly).
Key Characteristics
• Principal: Nominal, principal, par or face amount is the amount on which the
issuer pays interest, and which, most commonly, has to be repaid at the end of
the term.
• Coupon Interest Payment: Periodic Interest Payment to holder over life of the
bond.
• Maturity Date: Date at which “loan” is repaid
• The price of a bond: the price the bondholder pays the bond issuer to hold the
bond. The sum of the present values of all expected coupon payments plus
the present value of the par value at maturity.
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Overview of the Financial Industry
The Bond Market
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To illustrate how a bond works, let’s look at an 8% coupon, 30-year maturity bond with a par
value of $1,000, paying 60 coupon payments of $40 each.
Coupon rate = 8% Par value = $1,000 Therefore the coupon = 8% x $1,000 = $80 per year
Because this bond is a semiannual coupon, the payments are for $40 every six months. We
can also say that the semiannual coupon rate is 4 percent.
Since the bond’s time to maturity is 30 years, there are total of 30 x 2 = 60 semiannual
payments.
At the end of Year 30, the bondholder receives the last semiannual payment of $40 dollars plus
the principal of $1,000.
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Overview of the Financial Industry
The Bond Market
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Overview of the Financial Industry
The Bond Market
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This table
shows global
bonds to be
$157 trillion
out of the total
$212 trillion of
capital stock
(bonds plus
stocks) with
stocks at $54
trillion. That
means bonds
constitute
about 75% of
the total capital
stock.
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Overview of the Financial Industry
Summary of the Structure and Functions of an Investment Bank
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Structure:
─ Investment Banking Division (IBD)
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─
Sales & Trading (S&T)
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Sales/ Broker/ Dealer
Trading
Research
Asset Management (AM)/ Investment Management (IM)
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Product Group
Industry/ Coverage Group
Private banking
Institutional Management
Function:
─ Investment Banking Division (IBD)
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•
•
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─
Sales & Trading (S&T)
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M&A Advisory
IPOs
Underwriting
Structure Finance
Market-making
Asset Management (AM)/ Investment Management (IM)
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Private banking
Institutional Management
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Overview of the Financial Industry
Investment Banking
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Introduce the product vs. industry group distinction
─
Product Group (M&A, ECM, DCM, Leveraged Finance, Restructuring)
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Industry Group (Aerospace, Healthcare, Retail, Energy, TMT, Transportation)
Initial Public Offering (IPO)
1.
Initial Pitch
2.
Valuation
3.
Due Diligence
4.
Pitch books/ Sales Force Memo
5.
S-1
6.
Road Shows
7.
IPO
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Overview of the Financial Industry
Investment Banking
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League Table
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Overview of the Financial Industry
Investment Banking
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Hierarchy
─
Analyst
─
Associate/ AVP
─
Vice President (VP)
─
Executive Director/ Director
─
Managing Director
─
Global-Head/ Partner
─
Executive Officers (CEO, COO, CIO, CRO)
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Overview of the Financial Industry
Sales and Trading[use multiple slides if necessary]
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■ Proprietary vs. Flow Trading
- Proprietary trading involves making trades with the firms own money; the
Volcker Rule, introduced after the crisis, bans investment banks from
doing this
- Flow trading is the most common type of trading; it involves making
trades on behalf of clients, and then hedging
■ Sales vs. Trading
- Salespeople and traders have very distinct roles.
- Salespeople are the main contacts with banks’ trading clients (e.g. asset
managers, hedge funds, etc.) Their role is to suggest possible trades to
clients and to maintain relationships with them.
- Traders, on the other hand, have less contact with clients. They focus on
executing and hedging against trades.
■ Market Making
This involves wither matching buyers and sellers in the market (this is the
ideal situation) or acting as a source or liquidity or as a counterparty
■ Equities vs. Fixed Income
- Equities includes stocks and all derivatives based on stocks (options and
futures.)
- Fixed Income includes bonds, currencies, commodities, and derivatives
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Overview of the Financial Industry
Sales and Trading[use multiple slides if necessary]
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Overview of the Financial Industry
Investment Management
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Asset Management
─ Institutional investors
─ Essentially invest on behalf of clients
─ Various types of investment
─ Two major divisions
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Investment management: Research analyst  portfolio manger  trader
Client management: client supporting  client manager
Wealth Management
─ Private investors: HNW (high net worth) individuals (over $1 mm)
─ Covers full financial solutions: taxes, asset protection, investment, property advice
─ Essentially, the “front office” / “client manager” for many other divisions
─ Mostly relationship management (family)
─ Non-discretionary
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Overview of the Financial Industry
The Buy Side vs. the Sell Side
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Can use a table here, with investment banks on the sell side, and some asset managers/
hedge funds/ PE on the buy side. Define these if necessary.
List some example companies, PE firms, and funds on each side to get people familiar
with some of the big names and people
Also describe the career relationship between banks and the buy side (i.e. many people do
IB for 2-3 years to move to PE or hedge funds)
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Overview of the Financial Industry
Front vs. Middle vs. Back Office
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Finance-middle office
─ Increase and monitor profitability and efficiency
─ Communication and coordination
─ Main functions:
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Operations-back office
─ Main functions:
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P/L business performance
Audit
Company’s accounting
Valuations
Trade support
Monitoring and reporting
Client service
Transaction Banking
─ Trade and Treasury Solutions
─ Securities and Fund Service
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