Investment Banking & Hedge Funds

―Divya Moda ―Rohit Sharda

―Divyaksh Sehgal ―Sachin Gogia
―G Venkata Vijaya Kumar ―Sagar Mehta
―Ganesh V ―Sahil Pabby
Introduction to Investment Banking
• Underwriting, selling, and trading securities
(stocks and bonds)
• Providing financial advisory services, such as
M&A advice, fund raising
• Managing financial assets
• General advisory services like business
valuations, restructuring

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 Need for an Investment Bank??
• Example of an M&A transaction

• Example of a fund raising exercise

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 Evolution of Investment Banking
• Initially, financial engines of capitalism were
merchant banks
• Source of inspiration for financial firms across
Atlantic
• Two distinct models arose
• Old merchant banking model
• Financial firms acting as underwriter

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 Evolution contd……
• Great depression led U.S congress to act
• Commercial and Investment bank segregated
• The Glass-Steagall Act of 1933
• Dismantled in 1999
• The Securities Act of 1933 became a blueprint

Source: Investopedia

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 Effect of Sub-prime on i-Banking
• Heavy exposure to mortgage backed securities
resulted into heavy losses
• Close to $550 billion of losses reported
• The jolts were felt all across the board with
the banks filing for bankruptcy, converting into
corporate banks, and looking to hive off their
assets

Source: Wall Street Journal

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 Bear Stearns
• Investor losses mounted in 2006-07
• Company increased it exposure to Mortgage
Backed Securities
• Federal Reserve Bank of New York provided an
emergency loan
• Sold to JP Morgan at $10 per share

Source: Wikipedia

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 Lehman Brothers
• Largest bankruptcy filing in US
• Suffered bank debt of $613 billion, bond debt
of $155 billion
• Talks failed with Bank of America and Barclays
• Filed for bankruptcy on 15th Sept, 2008

Source: Wikipedia

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 Merill Lynch
• Lost $19.2 billion between July 07 and July 08
• E Stanley O’Neal was removed as Chief
Executive
• Announced to sell its commercial finance
business to GE
• Acquired by Bank of America on 14th
Sept,2008 for $29 per share

Source: Wikipedia

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 Citi Group
• Suffered a loss of $39.1 billion
• Eliminated 17000 jobs by April 2007
• Bailed out by US Govt- invested $20 billion in
the company

Source: Wikipedia

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 Carrier Growth in i-Banking

Source : ECC Investment Banking

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 An i-Banking Job Offers??
• Significant Learning Opportunities
• Strong networking opportunities with industry
biggies
• Enhanced analytical and technical skills
• HEFTY pay packages!!!!

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 What Is Expected Of You??
• Detail-oriented thinking
• Number crunching and analytical skills
• Excellent communication and people skills
• Ability to think critically

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 IT’s NOT ALL…..
• 365 x 24 x 7
• Tolerance for risk
• Job over personal life
• Survival skills

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 Hedge
• ‘To hedge’ in financial terms means to
minimize risk or insulate oneself.

• A hedge is a position established in one

market in an attempt to offset exposure to the
price risk of an equal but opposite obligation
or position in another market.

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 Hedge Example
Lets us consider two rival companies A and B in
the same industry.
Company A Company B
1000 Shares @ 10 Rs each 500 Shares @ 20 Rs each
LONG SHORT
• After DAY1 – Positive news in the Industry
1000 Shares @ 11 Rs each 500 Shares @ 21 Rs each
(10% increase) (5% increase)

Note: In a short position, the investor loses money when the price goes up.

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 Hedge Example (Contd..)
• After DAY N – Markets crash.
- Prices crash down to 50% within few hours.

Value of long position Value of short position

(Company B):
(Company A):
Day 1: - Rs10000
Day 1: Rs10000 Day 2: - Rs10500
Day 2: Rs11000 Day 3: - Rs 5250 =>
Day 3: Rs5500 => (Rs10000 (Rs10000 – Rs 5250)
- Rs5500) = Rs 4500 loss = Rs 4750 profit
Without the hedging the loss would have been Rs. 4500 (or even Rs. 9000),
but due to hedging – i.e. short-selling, we have a net profit of Rs 250 even
after a dramatic market collapse.

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 TYPES OF CORPORATE RISKS FACED
1. Business risks:
a) Commodity Risk
b) Concentration Risk
c) International operations Risk
2. Financial Risks:
a) Credit Risk
b) Forex Risk
3. Operational Risks

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 Business Risks
1. Commodity Risk:
a) Price risk
b) Risk of non availability
2. Concentration Risk
a) High susceptibility to unfavorable conditions
and events
3. International operations Risk
a) Political risks
b) Currency risks

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 Tools to hedge risks
• Derivative instruments:
– Forwards
– Futures
– Options
– Swaps
• Short selling

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 Forward Contract

• It is an agreement between two parties to buy or sell an asset

at a certain future time for a certain price agreed today.

• Example –

Ram - importer - has to make a payment in dollars for

consignment in six months time -not sure what the Re/$ rate
then - contract with a bank to buy dollars six months from
now at a decided rate - underlying security is the foreign
currency.

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 Future Contract
• A future contract is an agreement between two parties to buy or sell an asset at a
certain time in the future at a certain price. Index futures are all futures contracts
where the underlying is the stock index and helps trader to take a view on the
market as a whole.

• Example – A person buys a future contract through the Stock Market, thereby
agreeing to buy the underlying asset on a future date at a predetermined price.

• Details like Strike Price, Period, Underlying Asset, etc are standardized by the stock
market. It is not at the option of the contracting parties to change any details.

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 Forwards and Futures – A Comparison

Forward Contract Futures Contract

• Contract size & Expiry date • Contract size & Expiry date are
depend on the Parties standardized
• Transactions are Negotiated • Quoted and traded on the
directly by the parties Exchange
• Not regulated • Government regulated market
• Risk is Higher • Risk is Lower
• Termination- Similar opposite • Settle the Profit/Loss in cash as
contract taken on date of exit

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 Call Option
• A Call Option is a contract between two parties giving the taker (buyer) the right,
but not the obligation, to buy a parcel of shares at a predetermined price possibly
on, or before a predetermined date, from the writer.
• To acquire this right the taker pays a premium to the writer (seller) of the contract.

Example-
Sam purchases a December call option at Rs 40 for a premium of Rs 15. That is he
has purchased the right to buy that share for Rs 40 in December.
If the stock rises above Rs 55 (40+15) he will break even and he will start making a
profit.
Suppose the stock does not rise and instead falls he will choose not to exercise the
option and forego the premium of Rs 15 and thus limiting his loss to Rs 15.

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 Call Option

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 Put Option
• A Put Option is a contract between two parties giving the taker (buyer) the right,
but not the obligation, to sell a parcel of shares at a predetermined price possibly
on, or before a predetermined date, to the writer.
• To acquire this right the taker pays a premium to the writer (seller) of the contract.

• Example -
Sam purchases 1 INFTEC (Infosys Technologies) AUG 3500 Put --Premium 200
This contract allows Sam to sell 100 shares INFTEC at Rs 3500 per share at any
time between the current date and the end of August. To have this privilege, Sam
pays a premium of Rs 20,000 (Rs 200 a share for 100 shares).
The buyer of a put has purchased a right to sell. The owner of a put option has the
right to sell.

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 HEDGE FUND
• A hedge fund is an investment fund open to a
limited range of professional or wealthy
investors that is permitted by regulators to
undertake a wider range of investment and
trading activities than other investment funds
and pays a performance fee to its investment
manager.

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 Types of Fees
• Management fees
• Performance fees
• High water marks
• Hurdle rates
• Withdrawal/Redemption fees

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 Classifications
• Long/Short Selling: Estimation of overvalued
or undervalued stocks.

• Market Neutral: Value of long positions equal

short. Market risk reduced.

• Global Macro: Bet on movements in markets,

currencies, interest rates or commodities.
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 Classifications (Cont.)
• Futures Funds: Commodity or financial
instrument.

• Emerging Markets: Significant and sustained

growth. Volatile political and economic risk

• Event Driven: Bets on events specific to a

company or security.
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 Classifications (Cont.)
• Distressed Funds: Invest in companies that
could possibly return to profitability

• Aggressive Growth : Invest in companies that

small or micro capital and expected to grow
strongly.

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 Effect Of Subprime on the Hedge Fund
Industry
• Average Hedge Fund losses- Over 18%*
• Assets-Down by 30-40%*
• Number of Funds are likely to be down by half
• Investors & Clients-Tougher Bargainers
• Management Fees cuts likely
• Calls for Stricter Regulation
• 2008-Hedge Funds worst year
• *Source: Hedge Fund Research,2008

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 Why did this happen?
• Credit Crunch
• Ban on Short Selling
• Significant Investments in Illiquid assets
• Heavy Leveraging
• Forced Sale of Assets-”Fire Sale”
• Widening Client Base-Individuals to
Institutions
• Fear Of Redemptions
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 Some Notable Names
• JP Morgan Asset Management

• Goldman Sachs Asset Management

• Bridgewater Associates

• D.E. Shaw Group

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 THANK YOU

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