Chapter Chapter 55INVESTMENT INVESTMENT

BANKING FIRMSBANKING FIRMS

Inv. Banking activities are performed Inv. Banking activities are performed by;by;

• Securities firms and Securities firms and • Commercial banksCommercial banksSecurity firmsSecurity firms;;• Distribute newly issued securities,Distribute newly issued securities,• Involved in secondary market as Involved in secondary market as

market makers and brokers.market makers and brokers.Inv. Banking firms are Inv. Banking firms are highly leveragedhighly leveraged

companies.companies.Revenues:Revenues: Commissions, fee income, Commissions, fee income,

spread income, and principal.spread income, and principal.

Activities of the Inv. Banking Activities of the Inv. Banking FirmsFirms

1.1. Public offering (underwriting) of securities.Public offering (underwriting) of securities.2.2. Trading of securities.Trading of securities.3.3. Private placement of securities.Private placement of securities.4.4. Securitization of assets.Securitization of assets.5.5. Mergers & Acquisitions.Mergers & Acquisitions.6.6. Merchant banking.Merchant banking.7.7. Trading and creation of derivative instruments.Trading and creation of derivative instruments.8.8. Money managemetMoney managemet

1. Public offering (underwriting) 1. Public offering (underwriting) of Securitiesof Securities

The functions of the inv. Bankers;The functions of the inv. Bankers;

1.1. Advising the issuer on the terms and timing of Advising the issuer on the terms and timing of the offering.the offering.

2.2. Buying the securities from the issuer.Buying the securities from the issuer.

3.3. Distributing the issue to the public.Distributing the issue to the public.

Best Effort Selling: Best Effort Selling: The inv. Banking firm The inv. Banking firm agrees only to use its expertise to sell the agrees only to use its expertise to sell the securities. It does not buy the entire issue securities. It does not buy the entire issue from the issuer.from the issuer.

Underwriting:Underwriting: Inv. Banking firms buys the Inv. Banking firms buys the securities from the issuer and accepts the securities from the issuer and accepts the risk of selling the securities to investors.risk of selling the securities to investors.

-Stand-by underwriting-Stand-by underwriting

-Firm-commitment (Bought deal)-Firm-commitment (Bought deal)

Underwriting fee (Gross spread, Underwriting fee (Gross spread, Underwrite discount):Underwrite discount):

• The difference btw the price paid to the The difference btw the price paid to the issuer and the price at which the inv. issuer and the price at which the inv. banking firms reoffers the securities to the banking firms reoffers the securities to the public. public.

Underwriting SyndicateUnderwriting Syndicate

• Underwriting transaction involves the risk Underwriting transaction involves the risk of capital loss. To share this risk, an inv. of capital loss. To share this risk, an inv. banking firm puts together a group of firms banking firm puts together a group of firms to underwrite the issue.to underwrite the issue.

• Gross spread is divided among the lead Gross spread is divided among the lead underwriter(s) and the others. The lead underwriter(s) and the others. The lead underwriter manages the deal (runs the book for underwriter manages the deal (runs the book for the deal)the deal)

• To increase the potential investor base, the lead To increase the potential investor base, the lead underwriter puts together a underwriter puts together a selling groupselling group. This . This group includes the underwritring syndicate and group includes the underwritring syndicate and other firms not in the syndicate. other firms not in the syndicate.

• PrivatizationPrivatization: Inv. Banking firms may assist in : Inv. Banking firms may assist in offering the securities of gov-owned companies offering the securities of gov-owned companies to private investors.to private investors.

2. Trading of Securities2. Trading of Securities

• Revenue from this activity;Revenue from this activity;

1.1. Bid-ask spread. The diff. Btw the price at Bid-ask spread. The diff. Btw the price at which the inv. Banking firm sells the which the inv. Banking firm sells the security and the price paid for securities.security and the price paid for securities.

2.2. Appreciation of the price of the securities Appreciation of the price of the securities held in inventory.held in inventory.

The strategies of the traders to The strategies of the traders to generate revenue;generate revenue;

1. Riskless arbitrage; If price differences 1. Riskless arbitrage; If price differences occur in various markets for the same occur in various markets for the same security, investors can make profit after security, investors can make profit after transaction costs by selling the security in transaction costs by selling the security in the market where it is priced higher and the market where it is priced higher and buying it in the market where it is priced buying it in the market where it is priced lower.lower.

Security Price Payoff in

State 1

Payoff in

State 2

A $70 $50 $100

B 60 30 120

C 80 38 112

• 2. Speculation; occurs when the trader 2. Speculation; occurs when the trader positions the capital of the investment positions the capital of the investment banking firm to take advantage of a banking firm to take advantage of a specific anticipated movement of prices.specific anticipated movement of prices.

3.Private Placement of 3.Private Placement of SecuritiesSecurities

• Inv. Banking firms place securities with a Inv. Banking firms place securities with a limited nr. of institutional investors such as limited nr. of institutional investors such as insurance companies, inv. companies and insurance companies, inv. companies and pension funds.pension funds.

4.Securitization of assets4.Securitization of assets

• It is the issuance of securities using a pool of It is the issuance of securities using a pool of assets as collateral.assets as collateral.

• Asset-backed securities: Inv. Banking firms work Asset-backed securities: Inv. Banking firms work with corp. to either securitize a wide range of with corp. to either securitize a wide range of loans and receivables or buy loans and loans and receivables or buy loans and receivables in the market and issue securities receivables in the market and issue securities backed by them.backed by them.

5.Mergers and Aquisitions5.Mergers and Aquisitions

• M&A activities include;M&A activities include;– Leveraged buyouts (LBOs)Leveraged buyouts (LBOs)– Restructuring&recapitalization of companiesRestructuring&recapitalization of companies– Reorganization of bankrupt and troubled Reorganization of bankrupt and troubled

companies.companies.

Their M&A activities;Their M&A activities;

• Finding M&A candidatesFinding M&A candidates• Advising acquiring companies or target companies with Advising acquiring companies or target companies with

respect to price and non-price terms of exchange.respect to price and non-price terms of exchange.• Assisting acquiring companies in obtaining the Assisting acquiring companies in obtaining the

necessary funds to finance a purchase.necessary funds to finance a purchase.

They receive an advisory fee (retainer) based on the They receive an advisory fee (retainer) based on the percentage rate of selling price.percentage rate of selling price.

6.Merchant Banking 6.Merchant Banking

It is an activity of the inv. Banking firm It is an activity of the inv. Banking firm when it commits its own funds by either when it commits its own funds by either taking an equity interest or creditor taking an equity interest or creditor position in companies. position in companies.

7.Trading and Creation of 7.Trading and Creation of Derivative InstrumentsDerivative Instruments

• Futures, forwards, options, swaps are Futures, forwards, options, swaps are used to control the risk of an investor’s used to control the risk of an investor’s portfolio.portfolio.

• They are also used to protect an inv. They are also used to protect an inv. Bank’s own position in transactions.Bank’s own position in transactions.

8.Money management8.Money management

• Inv. Banking firms create subsidiaries that Inv. Banking firms create subsidiaries that manage funds for either individual and manage funds for either individual and institutional investors.institutional investors.

Investment services and activities of Investment firms in Turkey

1. They receive and send orders for the capital market instruments (order transmission intermediation)

2. They realize orders in the name and for the account of their customers as well as in their own name and for the account of their customers (trading intermediation)

3. They buy or sell capital market instruments from their own account (portfolio intermediation)

4. Portfolio Management5. Investment Couselling

6. They intermediate public offerings of capital market instruments through underwriting.

7. They intermediate public offerings without underwriting. (Best-efford selling)

8. They operate multidimentional buying and sellling systems and other organized market places out of exchanges.

9. They keep and manage capital market instruments for the name of customers and keep portfolios.

10.They provide other services and activities determined by the CM Board of Turkey

• Banks can engage in (1), (2), (3), (9) and (10)

• Investment and development banks can engage in all of them except (8)

1. Order TransmissionIntermediation

• Investment firms send the customer orders on CM instruments to another investment firms engaging in trading intermediation or portfolio intermediation.

• Investment firms (aracı kurum) and banks can engage in “order transmission” intermediation activity after they get permission from the Board.

2. Trading Intermediation

• In addition to the “order transmission intermediation” activity, buying and selling orders on CM instruments those are in the name and for the account of their customers and in their own name and for the account of their customers are send by the investment firms– to the exchanges or other orginized markets,– to an investment firm engaing in portfolio

intermediation

2. Trading Intermediation

• Investment firms (aracı kurum) and banks can engage in the trading intermediation activity after they get permission from the Board.

3. Porfolio Intermediation

• In addition to the “trading intermediation” activity, investment firms carry out the buying and selling orders of customers on CM instruments as a counter party.

• They buy or sell capital market instruments from their own account

• Investment firms (aracı kurum) and banks can engage in the portfolio intermediation activity after they get permission from the Board.

4.Portfolio Management

• It consists of the management of portfolios including different types of financial assets for the name of each customer on proxy basis other than the portfolios of the “Collective investment firms”.

• Individual portfolio management includes the management and buling up the portfolios by considering the risk and return preferences and the financial conditon of the customers.

4. Portfolio Management

• These institutions have to apply “”suitability test” (yerindelik testi) to their customers before they sign the outline aggrement (çerçeve sözleşmesi).

• The activity of portfolio management can be given by the investment firms (aracı kurum), investment and development banks and portfolio management companies after they get permission form the Board.

4. Portfolio Management

• These institutions;– Can not give any return guarantees to the customers– Have to document the investment decisions for the

customers– Have to clarify risk/return preferences of customers,– Have to show their effort in handling the customers’

portfolio of securities– Have to be fair among their customers

• The CMB regulations require that portfolio management services can be;– Given by experts with knowledge and proper

education and experience.

5. Investment Counselling

• Giving advice and interpretations, verbal and in writing, to customers on;– CM Instruments,– Issuers

• Inv. Counselling must be based on a written contract.

5. Investment Counselling

• The activity of investment counselling can be given by the investment firms (aracı kurum), investment and development banks and portfolio management companies after they get permission form the Board.

• These institutions have to apply “”suitability test” (yerindelik testi) to their customers before they sign the outline aggrement (çerçeve sözleşmesi)

5. Investment Counselling

• Inv. Principles:– No misleading recommendation can be given,– Inv. recommendations must be properly documented,– The customers’ financial status must be taken into

consideration,– No guarantee can be given on inv. returns,– Interest based conflict in all cases must be avoided,– Not free using information gathering for their own inv.

purposes without initially supplying them to their customers.

6. and 7. The Intermediation of public offerings

• Investment firms and investment and development banks in Turkey can engage in the intermediation of public offerings through underwring or best efford selling.

• There are four types of underwring activities in Turkey;– Stand by underwring (Bakiyeyi yüklenim)– Firm commitment (Bought deal) (Tümünü yüklenim)– Partially stand by underwriting (Kısmen bakiyeyi

yüklenim)– Partially firm commitment (Kısmen tümünü yüklenim)

6. and 7. The Intermediation of public offerings

• The intermediation of public offerings services also consist of – They help to determine the price, the amount and the

process of issue, – They apply to the Board with the required documents

needed for the approval of the registration statements (izahname)

– They form underwriting syndicate– Book-building (ön talep toplama)– They arrange both domestic and international

organizations (events) for selling the securities

6. and 7. The Intermediation of public offerings

• Investment firms and investment and developments banks can engage in underwriting and best efford selling services after they get permission from the Board.

• There must be a written agreement between these institutions and the issuer.

• Many underwrites may come together and form an underwring sydicate. There must be a leader underwriter.

• The must be a written agreement among the partnets of the underwriting sydicate.

8. The organization of market places other than exchanges.

• The Board can regulate and put some

rules on the establisment of the organized markets those– get together the buyers and sellers of the CM

instruments– intermediate the buying and selling – form systems and platforms for those activies

other than the exchanges

9. Keeping Services

Keeping and managing of CM instruments for the name of customers and keeping portfolios.

- Limited keeping services

- General keeping services

9. Keeping Services

• Limited keeping services: Consist of keeping services for;– Capital market instruments that are subject to

trading intermediation and portfolio intermediation,

– Portfolios that are related to the individual portfolio management services,

– Capital market instruments that are offered to public through underwriting or best efford selling.

9. Keeping Services

• General keeping services; these are the keeping services that are not related to the investment services and activities.

• Limited keeping services can be provided by investment firms which are allowed to provide one of the following services; trading intermediation, portfolio intermediation, individual portfolio management, underwriting or best-efford selling. General keeping services can be given by banks and invetment firms which are entitled to carry one of the activities above.

• These insttitutions have to get permission from the Board.

9. Keeping Services

• There must be a written aggrement (keeping agreement) btw the customers and these institutions.

Ancillary services of investment firms and portfolio mang. Comp. İn

Turkey1. They provide consultancy services on

capital markets2. They provide margin trading and short

selling limited to the transactions on CM instruments. And they provide foreign exchange services.

3. They do investment research and financial analysis on CM instruments or provide general recomendations.

4.They provide services about conducting underwriting

5. They provide intermediation services on borrowing and other sources of finance

6. Wealth management and finansal planning

7. They provide other services and activities determined by the CM Board of Turkey

1. Consultancy Services

• They provide investment plans for the firms by considering their long and short term financial objectives, risk preferences, cash requirements.

• They provide verbal and written advices and interpretations on financial analysis, financial sources, risk definitions and reduction, financial improvements through revenue generation.

• They provide verbal or written advices or interpretations on mergers and acquisitions, divestitures, reorganization, restructure.

2. Margin Trading and Short Selling and Foreign Exchange Services

• Margin trading is the use of credit to purchase securities

• You can borrow up to 50% of the marginable securities by using your own assets as collateral. (Initial Margin)

• Benefits;– Increase the purchasing power of the

investors.

Margin Trading

• Risks associated with margin borrowing;– The value of the securities you deposited or

purchased on margin may decrease.– If the equity in your account falls below the

min maintenance requirements (maintanence margin), a maintanence call will result.

– If the maintenance call occurs, you will be required to increase the equity up to the min. maintenance levels by immediately deposited additional funds or marginable securities.

Short-selling

• Sale of the borrowed securities that are not owned .

• It is required from the customers to deposit at least 50% of the deal for short-selling in cash or in securities.

• Marginable securities can not be used as equity in short sale deals.

Borrowing and Lending Activities

• Borrowed securities are lent by the lender to the borrower with a view the borrower makes short-sale and return them in a certain time span to the lender.

• Banks and brokerage firms may lend securities either from their own or customers portfolios.

• Customers who sign margin aggrements also routinely sign loan-consent form.

Margin Trading- Short-selling and Lending-Borrowing Activities

The communiqué of the CMB stipulates that;• Margin trading rates be limited to half of the net-

worth of banks and investment firms• Total of securities on credit, short sales,

securities on borrowing be limited to twice as much as their net worth

• Each such deal to a single customer cannot exceed 10 percent of the net worth of banks and brokers.

General investment advices

• They provide advices on the current and future (expected) prices of the CM instruments.

• They make interpretations on the values of the securities.

• They provide investment strategies and make research and provide information and make suggestions.

Services related with the performance of underwriting

services• They make financial, economic and

market analysis about the firms that want to issue their securities,

• They determine whether the financial statements of the issues are appopriate to the capital market regulations,

• They determine the information and documents which will be announced to the public

Intermediation services on borrowing and providing other

sources of finance• Sevices including;

– Finding financial sources in or out of the country,

– Determining the alternative financial sources,– Giving advices and making interpretations on

hedging financial risks.

Wealth management

• They provide advices on financial, legal and tax issues to individuals, families and groups.

• They make plans about the wealth of these groups.

• They try to manage the wealth of their customers that suits their customers’ investment purposes and preferences.