Financial Markets
> Types of Banks
> Investment Banking Details
Objectives
The objective of this lesson is to give you a good foundation in the finance industry and the various business lines that
operate within a bank.
You should also understand various financial products that banks offer and that you may end up working with.
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Different types of banks
There are four main types of banks we will be covering in this course:
• Manage the money supply in a single country or series of nations. Set monetary
policy goals.
Central Banks • US: Federal Reserve
• Europe: European Central Bank
• Offer general public financial products and services such as bank accounts and
Retail Banks loans.
• Provide a wide variety of comprehensive financial services; tailored to retail,
Universal Banks commercial and investment services.
• E.g., Deutsche Bank, Bank of America, HSBC
• A financial intermediary that performs a variety of services. Specializing in large and
Investment Banks complex financial transactions as well as acting as a broker or financial advisor for
institutional clients.
• E.g., Goldman Sachs, Morgan Stanley
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A Bank: The Basics
As hard currency came into existence, so the bank was born, traditionally taking surplus cash from lenders and acting
as a financial intermediator to borrowers.
Loan: a sum of money
lent from a bank
Deposit: a sum of money
left with a bank
e.g., 6% charged by the
bank for a loan – the
e.g., 3% paid by bank to
bank retains the 3% and
depositor
usually invests in money
markets
Fractional Reserve: banks assume that depositors will only want access to a fraction of their deposits at a time – the
rest they will invest in money markets.
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Interest Rates
Interest • A fee for the use of money
• A percentage of the loan or
Interest
deposit that is charged as
Rate
interest
• Annual percentage of rate
APR
of interest
E.g., You borrow $1000 at 6% for a year. After a year you must pay back $1060.
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Evolution of Banking
Modern Banking
Money Market OTD – Originate
Securitization
Funding to Distribute
Bank avoids
Move away from
Less reliance on Borrowing on Inter-Bank New Derivative Proprietary bearing risk of
issuing products
depositors Money Market Borrowing products Trading all new product
to retain them
issuance
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2008 Financial Crisis
Factors that led to the crisis:
Focus on Proprietary New
short term interest over regulatory Ring fencing
profits clients bodies
Inadequate
Return for Effect risk Transparent
risk assessments markets
risk taking
assessment
Junk debt Inadequate Stress resilient
Ethics and
traded in capital capital
culture
securities reserves reserves
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Retail Banking
Banking for individual consumers, they cover the following product types.
Current Accounts Mortgages Debit Cards
Savings Accounts Personal Loans Checks
Overdrafts Payments Money Transfers
Telephone Banking Branches Online Banking
Also known as chartered banks in Canada.
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Banks – Monetary Policy
Retail banks can set their own rates for lending and borrowing money to their clients. The rate to lend between banks
is usually set by the central bank.
LIBOR: Benchmark interest rate at which major global banks lend to one another in the international interbank market
for short-term loans. (Rate is calculated and published each day by the Intercontinental Exchange – ICE).
Barclays borrows at
Barclays
1.33% (set by Barclays lends
borrows at
Barclays) at 0.93% to
0.91% from
Barclays lends at HSBC (Set by LIBOR is an
HSBC (Set by
5.5% (set by Barclays) average – in
this case 0.92% HSBC)
Barclays)
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Central Banks – Interest and Inflation
Interest Rates: The percentage of principal charged by the lender for the use of its money.
Inflation: A quantitative measure of the rate at which the average price level of selected goods and
services in an economy increases over time. It indicates a decrease in the purchasing power of a nation’s
currency. Measured by CPI: Consumer price index and PPI: Producer Price Index
The central banks will make changes to interest rates to have an impact on inflation. (They usually have a
target of what inflation should be over a given time period.)
Encourages Spending Encourages Saving
Increases Inflation Decreases Inflation
Lower Interest Rates Raise Interest Rates
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Central Banks – Interest and Inflation
A higher interest rate should also lead to a higher exchange rate (more demand for the currency from abroad), which
helps to reduce inflationary pressure by:
Making imports cheaper (lower prices of imported goods)
Reducing demand for exports
Increasing incentive for exporters to cut costs
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Quantitative Easing (QE)
The Central Bank creates new money electronically - Quantitative Easing (QE)
This money is used to purchase Government Bonds or other assets
Increases bond prices, reduces yield and encourages/frees up money to be invested elsewhere, such as lending
Increased lending supply, lowers the cost of borrowing
Used when interest rates and inflation are very low and need boosting via spending
“Central Banks as a Safety Net”
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Corporate Banking
Banking for different size businesses offering retail banking services plus:
Multi-Bank Syndicated Loans
• Larger loans supported by a group of banks to spread the risk of the loan and raise the capital required, usually available at short notice,
cheaper than a bond issue
Foreign Exchange Facilities
• Providing competitive foreign exchange facilities including help with balance sheet analysis and hedging solutions and managing exposure
and risk to FX movements
Cash Management Services
• Movement of money between various accounts as needed
Letters of Credit and Guarantees
• Assurance from the bank that an exporter will be paid after shipping goods
Lines of Credit
• Business form of an overdraft but not set up as a negative balance on your account; the line of credit is set up on another account
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Private Banking and Wealth Management
Banking for high net worth individuals with more than In addition to retail services, they also offer:
$1 million of liquid assets.
Advice and management
Examples of such individuals: Tax planning
Entrepreneurs Personal relationship
Executives Investment planning
Landowners Wealth structuring
Celebrities Discretion
Royalty
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Investment Banking
Who are the clients of an investment bank?
• Assumed to be more informed investors and as such, are able to take
Professional more financial risks than other types of investor
• Have experience, knowledge and expertise to make their own investment
Clients decisions & risk assessment
• Covered by fewer regulatory guarantees
• Investment firms, pension funds, insurance firms, commodity dealers,
Institutional hedge funds, asset managers, national and regional governments,
sovereigns
Investors • International and supranational institutions: World Bank, IMF, Central
Banks
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Investment Banking
Services include:
Company Restructuring
Mergers and Acquisitions
Financing
Security Issuance Underwriting
Research and Advisory
Brokerage and Market Making
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IB – Research and Advisory
Research and advisory is often offered to clients free of charge to gain good will and encourage them to use other fee-
based services.
Buy/Sell/Hold • Stock ratings; portfolio balancing;
Recommendations overweight/underweight on securities
Financial Trends
• Market trends and consumer trends
and Forecasting
Politics and Macro • Information on major events and news, supply
Economics and demand
Market Analysis • Technical analysis and market risk models
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IB – Financing and M+A
Financing Mergers and Acquisitions
Used when a client needs to raise capital: Very lucrative part of the IB business.
Advice Why would you want to merge?
Investor Introductions Make money for shareholders (ideally)
Economies of scale, especially in areas such as
Syndicate Loans
research and development
Bond and Securities Issuance Gaining larger market share
Project Financing Better competition against other firms
e.g., Bank of New York and Mellon Financial
Corporation combined to form BNY Mellon.
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Capital Markets
Investment banks facilitate the operation of the capital markets alongside exchanges, brokers, interdealer brokers and
market data providers.
Markets have generally moved on from open out-cry trading, which has been replaced by electronic trading.
We split the markets into primary and secondary:
Primary Market Secondary Market
• “The market that raises medium- and long-term • Buying and selling of securities
financing (capital) for the issuers of share and bond • Trading
securities”
• New security issuance
• New bonds
• New shares
• IPOs
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Secondary Market Services
Brokerage - Brokers Market Making - Dealers
Broker Securities Match Buyers Make a Market for Offer a Buy and
Dealing and Sellers a Security Sell Price
Fees: Upfront, Long-Term Generate Fees Hold an Inventory
Spread Quarterly • Holding from the Buy - Sell of Securities to
Charge • Dividends Price Spread Supply This Service
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Investment Banking: Risks – Diversification
Diversification: A risk management strategy that mixes investments within a portfolio – this limits exposure to one type
of asset.
All investments involve some level of risk.
Operational Risk Market Risk Credit Risk
Financial and
• System, people, • Loss due to market • Defaults leading to
Reputational and process volatility financial loss
Damage failures
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Market Risk
These are four standard market risk factors: Prices rise and fall due to market sentiment
The risk that movements in prices lead to losses
Hedging to mitigate against market risk
Measured by different techniques including VAR
(Value-at-risk)
Commodity Interest Rates
Prices
FX Rates Stock Prices
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Investment Banking Trade Life Cycle
Investment banks are usually split up into front office, middle office and back office functions.
• Client-Facing: Interact with clients; build relationships
Front Office • Revenue-Generating: Sell research, advise,
brokerage
• Support: Support front office functions
Middle Office
• Validation: Verifying front office transactions
• Settlement: Daily trades are netted/paid and received
• Custody: Register new product owners
Back Office
• Regulatory Reporting
• Accounting: Financial reporting
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The 24-hour Banking Day
Depending on the business area the bank applications could be being used through 24 hours and potentially 7 days a
week (think online banking). This introduces follow the sun.
London/Euro Markets Open:
08:00 GMT
HK Market Open:
US Market Open: 01:30 GMT/09:30 HKT
14:30 GMT / 09:30 ET
Tokyo Market Open:
00:00 GMT / 09:00 JST
Follow the Sun Support Model
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Front Office Trading
Front office trading can be divided into proprietary trading, brokerage and research areas. There are rules around
what interactions these areas can have and they are generally separated by Chinese walls.
Proprietary Trading Brokerage Research
Buy Side Sell Side
Prop trading occurs when a trader The sell side is involved in creation, promotion and sale of stocks, bonds, fx and other
trades stocks, bonds, currencies, financial instruments.
commodities, derivatives or any other Investment bankers serve as intermediaries between security issuers and investing
financial instruments with the firm’s public and the market makers who provide liquidity in the market.
own money (nostro account)
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Types of Asset Classes
There are multiple types of asset classes that investment banks deal in.
Equities Cash and Money Commodities
• Shareholder equity: represents Markets • Tradable commodities consist of
the amount of money that would • Trade in short term debt – basic goods used in commerce;
be returned if all assets of the relatively low rate of return but e.g., energy. Usually executed
company were liquidated. through future contracts that
considered low risk
standardize quantity and quality
Fixed Income Foreign Exchange (FX) Real Estate
• An investment that provides a • The trading of currencies • Property made up of land as well
return in the form of fixed as anything on it; e.g., buildings,
periodic interest payments and natural resources and animals
eventual return of principle at
maturity
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