What Investment Bank Do?

What Investment Bank Do:

M&A, underwrite bond and stock

Shock for IB

Good Side:

1. Uncertainty make company and investment hold back.
2. Uncertain make the trading market volume goes up

Debt Market

        How business finance: Cheapest funding possible, always access to the market

                2008 financial crisis: Dogg Frank

                Recession: economic shrink, GDP negative

                Cheapest funding possible:

1. Issue Short term commercial paper(30days-90days)

Why not all do it: only very strong, high rated company could issue; other do not have access.

(Commercial paper went away in 2008)

1. Issue long term debt(30 years..) minimize risk → but more cost

*Cost vs. Risk trade off: P&G Company not influenced by recession would issue short term; Auto Company influenced by recession would issue long term

*flexibility vs. Cost: company want flexibility while investor don’t want flexibility→ tradeoff: cost company more to offer callable bond.

        Investor:  

1. Who are they:

1. Institutional investor: Pension Fund, Mutual Fund (May through asset management company who manage other people’s money) buy everything but each individual institutional investor just have narrow scope.  
2. Banks: loans, don’t buy stock or corporation bonds. They creates them and sell them to others.  
3. Different types of asset management ---Hedge Fund/VC Fund (private equity firm)
4. Corporate
5. Individual: director investor in stock and mutual fund and indirect in bonds.

1. Risk vs. Return

Return  

1. Mutual fund manager’s job is to beat the index. (ETS and mutual fund both invest index but ETS could do trade whenever but mutual fund only one time a day at certain rate)
2. Buyout funds/hedge fund/VC: promise the absolute return rate (high teen lower than 20)
3. Bank: make money on risk adjusted spread

Basil Rule: value risk weighted asset vs. Capital (fixed) the risked asset the higher capital you should keep → high risk adjusted return on equity (RAROC)

   Risk

1. Credit risk. Secondary market volume goes down, recognize loss in bonds even the bond is not default. ( credit rating)  -- bond investor risk
2. Interest risk. Interest goes up, value of bond goes down, risk goes up. (interest go up certain among, how much value bond goes down, duration) – bond investor risk
3. Liquidity risk (trading quote(sell&buy): buy low sell high) the spread show the liquidity risk – bond risk
4. Sector risk (bond in same sector, move same direction; Greek bond/Italian bond)

1. Form

1. Revolving: for certain time, the bank commit the company can borrow and repay borrow and repay. The amount they borrow company pay interest rate, if not the company not borrow, they pay commitment rate.
2. Term Loan A: pay back a little bit throughout 5 years (value based on if company has cash to payback)
3. Term Loan B: pay back 1% of principle every year, then the rest at final maturity. Longer maturity term than TLA. (value based on if company could re-finance again) –more credit risk for investors

*if the other is same, A has less risk than B, so in order to get people buy B, pay more to investor. Why not all do A: not have enough cash, so B has more flexibility than A in terms of how much cash company. Company can always pay back extra early if they find they have enough cash.

Loans are floating rate, so the investors do not have interest rate since it will match market rate. Loans can pay back without penalty. Loans are not security, less regulated.

1. Bond: issue another bond to pay back the previous at one time. Bond has interest rate. Pay back need penalty. Bonds are security – under Security Act 33, regulated.  

**

Investment Grade Company(Tribal B and above):

1. Loans and bonds are both not secured
2. loan are more expensive than bond for investment graded company; so company would have loan through revolver not intent to use it, but really finance on bonds
3. Using the loan market as a bridge to bond market:

For M&A transaction: buyer could do a revolver to show the seller have the money to buy, when the deal close, issue bonds.

Non-investment Grade Company(Tribal B below):

1. Loans(TLA &TLB) are secured; bond are not.  
2. Loans are cheaper than bond

Why they still have bond: not have enough from loan, or want longer maturity

1. Only Non-investment Grade Company has TLA AND TLB
2. Revolver & TLA → banks: revolver & TLA pro-rate (need pieces from Rev and TLA)

                                TLB → institutional

                Mortgage don’t follow these rules.  

**Why would not bank have so many types of bond out in market: don’t want make so small that won’t trade. Not a lot people do trading on those kind of bond.

1. Commercial paper (put cash and cash equivalent in here, low risk) Has own rating system.
2. Short term treasury bond

Risk off: negative return on Treasury bond (got to put money somewhere)

How to Issue

1. High yield bonds

1. Tie IPO with bond to banks → Relationship driven.

Company can say specifically that who write down bonds would get IPO, but banks could not require that.

Bunch of banks → geography, don’t want just sell in US, but other countries as well & lower price meaning lower coupon rate need pay.