Investment Banking

This document provides an overview of investment banking, including its historical background, structure, products, and the role of investment banks in capital market activities. It also discusses the risk factors in venture capital and private equity valuation methods.

Running head: INVESTMENT BANKING
Investment Banking
Name of the Student
Name of the University
Author’s Note

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Table of Contents
Requirement 1............................................................................................................................3
Requirement 2............................................................................................................................4
Risk Factors in Venture Capital.............................................................................................4
Private Equity Valuation Methods.........................................................................................4
Requirement 3............................................................................................................................5
Underwriting Risks Faced by Investment Banks in an IPO...................................................5
Auction Process for UK Government Securities...................................................................5
Requirement 4............................................................................................................................6
Requirement 5............................................................................................................................7
Six Tenets of Dow Theory.....................................................................................................7
Key Technical Techniques and Indicators for Successful Trading........................................8
Requirement 6............................................................................................................................8
Requirement 7............................................................................................................................9
How to Calculate Time-Weighted Returns (TWR)...............................................................9
Reason for Usefulness of Time-Weighted Returns..............................................................10
Requirement 8..........................................................................................................................10
1. Characteristics..................................................................................................................10
2. Settlement Method of Investment Transactions by Authorized Fund Managers (AFMs)
..............................................................................................................................................11
Requirement 9..........................................................................................................................11
Use of Derivatives by Investment Bankers..........................................................................11
Credit Default Swaps (CDS)................................................................................................12
Systematic Risk....................................................................................................................12
References................................................................................................................................13

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Requirement 1
i. Historical Background: Tadawul is considered as the only stock exchange in Saudi
Arabia and it is also the main stock exchange in the Gulf Cooperation Council (GCC)
countries. Only 14 companies were listed as the market was informal through 1970s.
However, the government of the country developed a ministerial committee for
developing and regulating market. The Capital Market Authority (CMA) was
developed in 2003 as the sole regulator of the market and this led to the development
of Tadawul or the Saudi Stock Exchange in 2007 (tadawul.com.sa 2019).
ii. Structure and Operation: The Saudi Stock Exchange is a joint stock company as per
the structure and it is also considered as the sole entity in Saudi Arabia in order to act
as the Security Exchange. In case of the operations, the Saudi Stock Exchange
involves in carrying out listing and trading in securities, along with deposits, clearing,
transfer, settlement and registration of the ownership of the securities trade in the
Exchange (tadawul.com.sa 2019).
iii. Products and Markets: The products of Saudi Stock Exchange are equities, Real
Estate Investment Traded Funds (REITS), sukuk, bonds, ETFs and others. In addition,
Saudi Stock Exchange operates in certain market; such as energy, material, capital
goods, transportation, media, retail, food and beverage, banks, insurance,
telecommunication, utilities, real estate and others (tadawul.com.sa 2019).
iv. Role of Investment Banks in Capital Market Activities: The major roles of
investment banks in the capital market activities is to serve as kind of intermediaries
between the investors and companies with the use of IPOs (initial public offerings). In
addition, investments banks provide their clients with underwriting services for the
issue of new stock when a company takes the decision to go public with the aim to
seek equity funding (Webb and Martin 2017).

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Requirement 2
Risk Factors in Venture Capital
The involvement of certain risk factors can be seen in Venture Capital and they are
discussed below:
i. Venture capitalists have to face the Market Timing Risk and it is the risk of launching
the business at the right time. Though this risk is tough to evaluate, but it is an
essential aspect that the venture capitalists need to consider (Korteweg and Nagel
2016).
ii. The absence of a clear and concise business model creates huge risk for the venture
capitalists as the adoption of wrong business model can affect the profitability and
return for the venture capitalists.
iii. Another major risk is related with the management team of the companies as the
venture capitalists invest in the companies run by successful management. The
absence of this kind of management is a major risk factor for the venture capitalists
(Korteweg and Nagel 2016).
Private Equity Valuation Methods
There are three major private equity valuation model for the companies and they are
discussed below:
Discounted Cash Flow (DCF) – DCF is a specific equity valuation method that is used for
the estimation of an investment’s value on the basis of future cash flows. It uses discounted
rate for finding the present value of exacted future cash flows. A present value estimate is
then used for evaluating a potential investment (Jenkinson, Sousa and Stucke 2013).

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Asset Valuation – This asset based valuation method of a company’s equity considers the
value of the assets and liabilities of a business. As per this method, a business’s value is
equivalent to the difference between the value of all assets and the value of all liabilities.
Sum of Parts – Sum of Parts method is considered as another crucial equity valuation model
which helps in the determination of the fact that what division world be worthy in case the
business is liquidated or there is acquisition of the business (Jenkinson, Sousa and Stucke
2013).
Requirement 3
Underwriting Risks Faced by Investment Banks in an IPO
During the process of IPO, investment banks buy the first stock of the companies that
goes public. However, there are certain underwriting related risks that these banks have to
face and they are mentioned below:
 The investment banks have to face the risk of unsold shares. It implies that the shares
they have bought with their own money, no one wants them. This is considered as a
huge risk. No one is purchasing the stocks that the banks are holding.
 The investment banks put their best effort to sell the shares they have bought, but no
one is interested in these shares. This is considered as a major risk for the investment
banks as they have to incur huge losses (Stowell 2017).
Auction Process for UK Government Securities
The auction process of UK Government securities include four steps and they are
mentioned below:
i. Before the eight calendar day of the auction, the amount of stock to be auctioned is
announced in the Auction Announcement form. After that, the publication of the
Prospectus and application form is done. Then, the listing of these stocks in the

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London Stock Exchange is done with “When-Issues” ISIN and Sedol codes. These
temporary identification codes help in forward treading of the stocks.
ii. After the completion of the auction, the publication of the auction results is done in
the press release form.
iii. This step involves in the settling of the “When-Issued” trades on the date of auction
settlement.
iv. The allocation of new ISIN and Sedol numbers are done in the post auction period. In
the specific scenarios where a new trench of existing stocks is issued, the allocation of
the codes of the existing stocks is done to the security (londonmarketsystems.com
2019).
Requirement 4
Efficient market hypothesis is an essential hypothesis and it state that the price of a
stock effectively incorporate all the major public data and information; and the consideration
of the prices is done as minimal determination for the value of the original investment. In
finance, behavioural models are considered as important aspects due to the fact that it
identifies and understands the implications for systematic markets for key decision methods.
The model under the traditional finance takes into account the investor and these investors act
rationally. Capital asset pricing model, modern portfolio theory and arbitrage pricing theory
are considered as the major quantitative models that consider the ratio expectation based
models (Arthur 2018).
The rise of behavioural model pattern is the major outcome of the issues faced by the
traditional models. Its key focus can be seen in major alternative for investments which are
not always based on the rationales and it helps in determining the phenomena of investment
market based on two key principles; first, there is failure from the agents in regularly

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updating the major beliefs perfectly, and second, the main reason for investment alternatives
is systematic deviation from the normative process (Hodrick 2014).
Another major focus on behavioural model is to carry out the argument that arbitrage
has a strict limit that licenses the investors to be rationally consistent and long live on the
overall price impact. Thus, the behavioural models emphasize on experimental evidence of
the reasoning psychology for the determination of the irrationality of the investors. Major
success of behavioural model can be seen to identify and explain irregularities in the stock
prices to overall overreaction, under reaction and momentum strategies. For these reasons,
behavioural models are considered as most efficient to determine the fluctuations and
irregularities in the stock prices (Helbing 2013).
Requirement 5
Six Tenets of Dow Theory
The six tenets of Dow Theory are mentioned below:
1. The Average Discounts Everything – This tenet states that the market imitates every
possible intelligible factor affecting the overall demand and supply and it is the basic
of the technical theory (Filipović, Mirjanić and Ljutić 2018).
2. Three Trends in the Market – As defined by Dow, uptrend can be considered as a
situation where each successive rally closes higher as compared to the previous rally
high.
3. Key Trends have Three Phases – As per Dow, major trends occur in three phases;
they are accumulation phase, public participation phase and distribution phase.
4. The Average must Confirm Each Other – Dow states that a bull or bear market
cannot occur until same signal comes from both the averages.

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5. Volume must Confirm the Trends – As per Dow, volume is a secondary but
essential factor in the confirmation of the price signals (Tsinaslanidis and Zapranis
2016).
6. Trend Continues, unless Definitive Reversals Come About – As per this tenet, an
object in motion tends will continue in motion until certain external factors causes
change in direction in it.
Key Technical Techniques and Indicators for Successful Trading
The key technical techniques and indicators for successful trading are discussed
below:
Moving Average – This technique helps in smoothing the data through the creation of a
single line of flowing and this line represents the average price of the stocks for a particular
period.
Moving Average Convergence Divergence (MACD) – This is considered as a wavering
indicator that fluctuates below and above zero. Thus, it is considered as both momentum and
trend-following indicator and technique (Yazdi and Lashkari 2013).
Relative Strength Index (RSI) – It is another wavering indicator, but it provides certain
different information as compared to MACD as its movement is covered between zero to
hundred.
On-Balance Volume (OBV) – This takes higher volume of information in order to compile it
into a single-one line for measuring the cumulative buying or selling pressure (Ding, Fang
and Zuo 2013).

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Requirement 6
Following the great financial crisis of 2008-2009, much of the blames were imposed
on the large financial institutions due to their taking of high-level of risk before the financial
crash. From the year 1933 to 1999, the commercial and investment banks were majorly
separated and same company could not own them. This step was considered as necessary as
the Federal Reserve initiated insuring the deposits of banks from risk. Allowing these two
kinds of banks to merge adhered major fuel to the fire of the financial crisis. There are many
arguments that the introduction of Glass Steagall Act of 1933 spread the seed of the great
recessive as it allowed the merger of the commercial and investment banks. At the same time,
there are many people who believed that the merger of these two types of banks cannot be
blamed as these merger institutions provided a great performance at the time of the crisis
(Gambacorta and van Rixtel 2013).
Before the depression, unit-baking laws controlled the banks in United States and
made it difficult for the banks in diversifying their risk portfolio. In the year 1999, congress
passed the Gramm-Leach-Bailey Act with the aim to replace the last portion of Glass Steagall
that separated the investment and commercial banks. Due to this, banks become able in
bearing potentially risky investment portfolio. For this reason, many blame the Gramm-
Leach-Bliley act to make the banks risky institutions too big to fail. At the same time, others
including former President Bill Clinton counter that this act has assisted the economy at the
time of the crisis as the commercial banks struggle more than the investment banks at the
time of recession. Thus, it can be said that the ultimate risk appears to be the moral hazard for
protecting the banks, not the union of the commercial and investment banks (Partnoy and
Eisinger 2013).

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Requirement 7
How to Calculate Time-Weighted Returns (TWR)
Three steps need to be followed for the calculation of TWR. First step involves the
calculation of the rate of return of each sub-period by subtending the period’s beginning
balance from the ending balance and dividing the result by the period’s beginning balance.
The next step involves in creating new sub-period for every period that change in cash flow is
there and whether it is deposit or withdrawal. Multiple period each with rate of return will be
left. Then, 1 needs to be added to each rate of return for making the calculation of negative
returns easier. The last step involves in multiplying the rate of return with each sub-period.
Then, the result needs to be subtracted by 1 for getting the TWR (Marty 2013).
Reason for Usefulness of Time-Weighted Returns
TWR is very much popular and useful to the investors due to the fact that it breaks up
the returns of an investment portfolio into the separate intervals on the basis of the fact that
whether money has been added in the fund or withdraw from the fund. After that, investors
can obtain the rate of return of each interval or sub-fund from the TWR that has changes in
cash flows. Since TWR isolates the returns with the changes in cash flows, investors can get
more accurate results than simply considering the commencing and ending balance of the
time invested in a fund. Moreover, TWR involves in multiplying the returns for each sub-
period or holding-period that helps in linking them together so that it can be shown that how
the returns are compounded over time. All these aspects together help the investors in gaining
the desired returns from their investments (Kasikci and Rajasingam 2017).

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Requirement 8
1. Characteristics
I. Life Funds – The main characteristic of life funds is that they are made up of stocks,
cash and alternatives into which life insurance premiums of policy holders are paid
into and claims are paid out (Sievänen, Rita and Scholtens 2013).
II. Pension Funds – Pension plans ate build on corpus of funds that is used for satisfying
the financial needs. They have limited period payment term, tax benefits and lifelong
income facility.
III. Investment Trusts – The main characteristic is that it has fixed capital structure that
provides the opportunity for longer-term view on the investment opportunities. It has
lowest fees and one can gain access to professional expertise.
IV. OEICs – These are professionally-managed funds that gain diversification through
investing in a group of equities instead of a single stock.
V. Unit Trusts – Unit trusts encourage the investors to invest in equities, debts,
derivatives and money markets as they take care all types of objectives of investment.
VI. SICAVs – These funds are mostly used in France, Italy and Luxembourg and they do
not have fixed number of shares traded in the public market.
2. Settlement Method of Investment Transactions by Authorized Fund Managers
(AFMs)
AFMs use certain method for settling the due of investment transitions. A settlement
date for investment transition is the data on which it is considered that the transaction is
finalized and closed. Thus, the AFMs make the money that the investors own available to
their accounts for covering the purchased shares by the date of trade settlement. Like this, the
proceeds from the fund shares redemption should be deposited to the account of the investors

12INVESTMENT BANKING
by the date of trade settlement. In addition, the AFMs need to close as well as settle the
money market funds on the same day as the trade date (Stowell 2017).
Requirement 9
Use of Derivatives by Investment Bankers
Major use of derivatives can be seen among the investment bankers. These investment
bankers use the derivatives for hedging and reducing the involved risks in the operations of
the banks. For example, the financial profile of a bank can be exposed to risk of change in
rate of interest. For this reason, the investment bankers can purchase interest rate futures for
protecting themselves from the change in interest rate. This is how the investment bankers
use derivatives (Li and Marinč 2014).
Credit Default Swaps (CDS)
CDSs can be considered as a type of insurance that is done against the risk by a
particular firm. The firm and the default are called as reference entity and credit event
respectively. It involves contract between two parties which are protection buyer and
protection seller. As per CDS, compensate is provided to the protection buyer for any kind of
loss raised from a credit event under a reference instrument. In return, the pretention buyer
ensures periodic payments to the protected seller (Hilscher, Pollet and Wilson 2015).
Systematic Risk
Systematic risk is also considered as volatility risk or market risk; and it indicates the
inherent danger in the unforeseen nature of the market. This risk has certain impact on the
whole market instead of the individual securities. Systematic risk comprises of the effects of
recession, change in interest rate and inflation on the whole market and thus, it is considered
as extremely volatile. It is not possible to leverage it with the help of diversification. For
example, development of a diversified portfolio through bonds and stocks can lead to

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systematic risk to that extent that a rise in interest rate can increase the stock values (Savor
and Wilson 2016).

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