Notesale: Turn your study into money

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Overview of investment banking
Monday, 31 October 2016

2:03 pm

Learning objectives:
- Key elements of investment banking
- Principles of investment banking
- Their significant role in the financial crisis
- Shadow banking and the repo market
Investment banks and the role of reputation
- Investment banks deal with moral hazard and asymmetric information
just like commercial banks
- They are just an intermediary between issuer of security and the
investors - they simply underwrite the securities and do not take the
money
- It’s the reputation of the bank that makes it possible for them to issue
securities
The role of the reputation in the market?
- The underwriting process is extremely important as it allows users of
securities to take advantage of the reputation of underwriters
○ They at as intermediaries who match the issuer of securities to
buyers of the securities
- Investment bankers, compared to traders in the market, cultivate an
image of sober responsibility and good citizenship as they thrive on
reputation
BIGNEWS:
- Investment banks have been under the media spotlight in recent years
because many of them are bucking in the financial crisis
○ Bear Stearns
○ Goldman sachs
○ Lehman brothers
○ UBS
○ Merril lynch
- Bear Stearns was the first US investment bank to face troubles in the
financial crisis
○ In 2007
○ Some of their funds collapsed due to investment in subprime
mortgages
○ One of the funds was the 'bear Stearns high- grade structured

- Bear Stearns was the first US investment bank to face troubles in the
financial crisis
○ In 2007
○ Some of their funds collapsed due to investment in subprime
mortgages
○ One of the funds was the 'bear Stearns high- grade structured
credit fund' and there was another one called 'bear Stearns high
grade structured credit enhanced leveraged fund'
§ High grade indicates that it is supposed to be a safe and
low risk investment
§ But the investment in subprime mortgages were risky;
leverage is risky as well
§ Leverage - to borrow money to purchase risky assets
(subprime mortgages)
§ They borrowed 80% of the money and the securities only
had to lose 20% for the fund to be wiped out - bear Stearns
had to pay out $3
...
9mil; Moody's
investor service announced that it was reviewing Lehman's
credit rating for a downgrade
§ On 11 Sep, these developments and the frigility of their
financial position led to a 42% plunge in the stock market
§ On 15 Sep, they declared bankruptcy afrer failed takeovers
by Barclays and Bank of America

financial position led to a 42% plunge in the stock market
§ On 15 Sep, they declared bankruptcy afrer failed takeovers
by Barclays and Bank of America

Lehmans price on NYSE
§ Their collapse had an impact on the global financial market
for weeks as it was a major player both demestically in the
US and overseas
§ Their bankruptcy led to a loss of $46bil of its market value
§ The US government decided to let them fail, compared to
them choosing to support Bear Stearns (acquired by JP
Morgan Chase with a $29bil loan from the SEC)

Impact on the financial market
Shadow banking:
- Consists of various financial institutions such as money market funds,

Impact on the financial market
Shadow banking:
- Consists of various financial institutions such as money market funds,
private equity funds, hedge funds and investment banks
- Shadow banks often take on risks that traditional banks are willing;
restricted from taking because of regulations

- Shadow banks act like banks but are not regulated
- Theyre not transparent - lack of disclosure
Shadow banking's contribution to the crisis:
- They were vulnerable because they borrowed short term in liquid
markets to purchase long term illiquid and risky assets
- The trade a lot in OTC derivative markets
- The shadow banking system has been blamed for contributing to the
2007-2008 financial crisis
Repo example:

- The shadow banking system has been blamed for contributing to the
2007-2008 financial crisis
Repo example:

When did the financial crisis start?
- The banks gave out loans despite the knowledge that mortgage
applicants were not qualified to borrow
- Loans were backed with securitized bonds (MBS) and were sold to
insurance companies, funds etc
- PROBLEM - the banks had been using these toxic assets to secure
funding in the repo market
○ Higher leverage can pose higher risk of insolvency
- According to Thomas Reuters, nearly 14tril worth of complex
securitized products were created
○ Subprime mortgages accounted for 1
...

○ Banks were withdrawing from volatile situations
○ The market became even worse as a result of this
Treasury crash
○ Government bonds are also susceptible to such crashers
○ As banks are bailing, high frequency traders are providing
liquidity



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