INVESTMENT BANKING

(1) Investment Banker

An investment banker does both fund-based and fee-based services. In

most cases, he buys new securities from issuers (companies) and sells them to
the retail investors. He also acts as the market maker for securities. The
investment banks in the US also do stock trading, underwriting, broking, asset
management and corporate advisory.

In India, only a very few merchant bankers do such investment function by

putting their own capital. It is more of a fee-based activity here.

(2) Merchant Banker

According to SEBI: ‘a merchant banker is one who is engaged in the

business of issue management either by making arrangements regarding selling,
buying or subscribing to the securities as manager, consultant, advisor or
rendering corporate advisory services in relation to such issue management’.

• A merchant banker is a resource mobiliser as well as an advisor to

the companies.

• He assists the companies to raise capital to raise the capital by

placing securities with investors.

• He does all the drafting and printing of offer documents.

• He appoints other market intermediaries to ensure the successful

marketing of the issues.

(3) Categories of Merchant Bankers

Before some of the changes made by SEBI in September 1997, there were four
categories of merchant banker:

• Category I – Capital adequacy of Rs. 5 crores.

• Category II – Capital adequacy of Rs. 50 lakhs.

• Category III – Capital adequacy of Rs. 20 Lakhs.

• Category IV – No capital adequacy requirement.

At present, only one category (Category I) could function as the merchant

banker. The authorised activities of a merchant banker include issue
management, corporate advisory relating to the issue, underwriting, portfolio
management services, managers, consultants or advisors to the issue. All those
who take up merchant banking activities will have to fulfil the capital adequacy
of Rs. 5 crores of net worth.

(4) Book Building Method

In book building method, unlike the fixed price offer the price is not
determined in advance. So is the case with the number of shares to be issued.
However, in the case of public issues by Indian companies, the number shares
offered is known before the issue is made. The indicative floor price or the price
band is announced by the issuer and the applicants for shares are asked to
mention their preferred price and the number of price they want to apply.

(5) Book Running Lead Manager (BRLM)

• In the pre-issue stage the BRLM has to deal with stock exchange, SEBI and
the Registrar of Companies (RoC) for filing the red herring prospectus.
Further, the registrars to the issue, underwriters and the bankers to the
issue are appointed by BRLM.

• During the issue, BRLM monitors the response and the status of the
number of bids received is ascertained.

• In the post-issue stage, the number of shares applied for and the price
bids are analysed by the BRLM. He assesses the demand and in
consultation with the issuer fixes the final issue price. This price is also
called as the cut off price.

(6) Red Herring Prospectus

A red herring prospectus does not specify the issue price and the quantity
of shares offered to public. Only the issue capital is mentioned. The prospectus is
prepared by the merchant banker by getting all the information from the
company management. Discussion with the management and personal visits to
the plant are done to gather the information

(7) Due Diligence Certificate

A merchant banker is responsible for verification of the contents of the

prospectus or the letter of offer and reasonableness of the views has to be given
by expressed therein. A due diligence certificate has to be given by the lead
manager in Form C. The certificate is to the effect that the lead manager has
examined various documents for adequate disclosures to investors and the draft
prospectus or the letter of offer is in conformity with the documents examined by
him. Further, it states that the legal requirements have been compiled with and
the level of disclosures is such that it is adequate for the investor to take an
informed investment decision.

(8) Compliance Officer

 A compliance officer is appointed by the lead manager. He is responsible
for monitoring the issue process. The compliance officer shall monitor the
compliance of the Act, rules, guidelines, regulations and notifications of SEBI or
the government. The officer is also responsible for the redressal of investor
grievances.

(9) Syndicate Members

They work as intermediaries for Issuer Company and the buyers of the IPO
stocks. Syndicate consists of other merchant banks, QIBs, stock broking firms
and sub-brokers. Investors submit their bids for IPO shares through Syndicate
Members appointed by the Issuer Company. They are also known as 'The
Members of the Syndicate'. The Members of the Syndicate circulate copies of the
Red Herring Prospectus along with the bid cum application form to potential
investors. They are also responsible for accepting the bids, payments and
application forms for the public issue. After receiving the bid for IPO Shares from
an investor, Syndicate Members enters bidding detail into the electronic bidding
system and generates a Transaction Registration Slip ("TRS") for each price and
demand option and give the same to the bidder. The Members of Syndicate
deposit all the money received from investors to the Escrow Account opened by
the Issuer Company. The Bid cum Application Form along with other supporting
documents is then sent to the registrar of the issue for further processing.

(10) IPO Registrar

IPO Registrars are independent financial institutions registered with stock

exchanges and appointed by the company going public for mainly to keep record
of the issue and ownership of company shares. Responsibility of a registrar at
the time of IPO involves, processing of IPO applications, allocate shares to
applicants based on SEBI guidelines, process refunds and transfer allocated
shares to investors demat accounts. Investors can contact the Registrar to the
Issue in case of any pre-Issue or post-Issue related problems such as non-receipt
of letters of allotment, credit of allotted shares in the respective beneficiary
accounts, refund orders etc. Name and contact information of IPO registrar is
published in the IPO forms, Issue prospectus etc.,

(11) Auction Process

It is a sell-side transaction situation where investment bankers approach

dozens of buyers (both financial and strategic) and accept bids. Most investment
banker led engagements tend to be auctions. However, given the competitive
environment auctions create, buyers often grow weary chasing deals that fall to
other bidders. This is why many private equity firms spend significant time
looking for proprietary dead flow (transaction flow where an investment firm has
an opportunity to review a deal before other potential acquirers)

(12) Boutiques
 Investment banking firms usually operate in all types of financial services.
But some companies operate in certain niche areas and they are called as
‘boutiques’.

(13) Bulge Bracket

It is a category of largest world-wide investment banks. Bulge bracket

firms serve as a one-stop shop to large corporate clients with the resources and
service abilities to handle nearly any financial engagement. Examples of bulge
bracket investment banks include Goldman Sachs, Merrill Lynch, Lehman
Brothers, and Morgan Stanley.

(14) Confidential information memorandum (CIM)

It is glossy booklet that describes a business and its financial performance.

Also known as the "book", the CIM is prepared by investment bankers in a sell-
side advisory engagement and distributed to potential financial and strategic
buyers after the execution of a non-disclosure agreement (Legal contract
between two parties that outlines confidential material).

(15) League Tables

They are third party organized listings that rank investment banks by
activity in various categories such as IPOs, bond issues, advisory engagements,
amongst other services. League tables help the potential clients to know about
which banks rank well for specific services.

(16) Lehman Scale

It is often used formula for determining a banker's fee for handling a

successful client engagement.

The Lehman scale formula is based on a transaction's total value and equals the
sum of;

• 5% of the first $1,000,000, +

• 4% of the second $1,000,000, +

• 3% of the third $1,000,000, +

• 2% of the fourth $1,000,000, +

• 1% of the remaining total

For example, on a transaction valued at $10 million, a banker using the Lehman
formula would generate a fee of $200,000
{$50,000 (5% of $1,000,000) +

$40,000 (4% of $1,000,001 to $2,000,000) +

$30,000 (3% of $2,000,001 to $3,000,000)+

$20,000 (2% of $3,000,001 to $4,000,000) +

$60,000 (1% of $4,000,001 to $10,000,000)

= $200,000}

(17) Tombstone

Tombstone is the Public announcement by an investment bank indicating

its role in a financial transaction or successful client engagement. Tombstones
are also used by private equity firms to announce acquisitions and divestments.

(18) Qualified Institutional Buyers (QIBs)

A Qualified Institutional Buyer is a purchaser of securities that is deemed

financially sophisticated and is legally recognized by security market regulators
to need less protection from issuers than most public investors. Typically, the
qualifications for this designation are based on an investor's total assets under
management as well as specific legal conditions in the country where the fund is
located. Certain private placements of stock and bonds are made available only
to Qualified Institutional Buyers to limit regulatory restrictions and public filing
requirements.

(19) Valuation

The term valuation implies the estimated value of an asset or a security or

a business. The alternative approaches to value a firm/an asset are: (i) book
value, (ii) market value, (iii) intrinsic value, (iv) liquidation value, (v) replacement
value (vi) salvage value and (vii) fair value

Book value is the amount at which an asset is shown in the balance sheet
of a firm Market value is the price at which an asset can be sold in the market.
Intrinsic value is equal to the present value of incremental future cash inflows
likely to accrue due to the acquisition of an asset, discounted at an appropriate
discount rate. The fair value is the average of book value, market value and
intrinsic value.

(20) Liquidation Value of a Firm

Liquidation value measure is guided by the realisable value available on

the winding up/liquidation of a corporate firm. Liquidation value is the final net
asset value (if any) per share available to the equity share holder. The value is
given by,
Net asset value per share = (Liquidation value of assets – Liquidation expenses –
Total external liabilities)/Number of equity shares issued and outstanding.

(21) Appraisal Value

Appraisal value is a method of determining a firm’s value. Such a value is

acquired from an independent appraisal agency. This value is normally based on
the replacement cost of assets. It is an important factor in special situations such
as in financial companies, natural resource enterprises or organisations that
have been operating at a loss.

(22) Capitalisation Rate

Capitalisation rate (capitalisation factor), normally expressed in

percentages, refers to the investment sum that an investor is willing to make to
earn a specified income. For instance, 12.5% capitalisation rate implies that an
investor is prepared to invest Rs. 100 to earn an income of Rs. 12.5 or an
acquiring firm is prepared to invest Rs. 100 to buy the expected profits of Rs.
12.5 of another business.

Businesses that exhibit higher business and financial risks obviously

warrant a higher capitalisation factor. Conversely, businesses carrying a low
degree of risk are subject to lower capitalisation factor.

(23) Explicit Forecast Period

It is the period in which the firm grows at a rapid pace; it is said to be at

saturation point at the end of the explicit forecast period, so far as growth rate is
concerned. The firm is expected to have attained a steady state and starts
growing at a stable growth rate, which is likely to continue in future years. The
value determined after the explicit forecast period is referred to as the
Continuing Value.

Where,

NOPLAT = the normalised level of Net Operating Profits less adjusted taxes in
the first year after explicit forecast period.

g = the expected growth rate in NOPLAT in perpetuity.

ROIC = the expected rate of return on the net new investment.

= Overall cost of capital

(24) Corporate Restructuring

 Corporate restructuring implies activities related to expansion/ contraction
of firm’s operations or changes in its assets or financial or ownership structure.

(25) Merger

A merger is a combination of two or more firms in which only one firm

would survive and the other would cease to exist, its assets/liabilities being
taken over by the surviving firm.

(26) Amalgamation

An amalgamation is an arrangement in which the assets/liabilities of two

or more firms become vested in another firm. As a legal process, it involves
joining of two or more firms to form a new entity, or absorption of one or more
firms with another.

(27) Horizontal Merger

Horizontal Merger takes place when two or more corporate firms dealing in
similar lines of activity combine together. Elimination or reduction in
competition, putting an end to price-cutting, economies of scale in production,
research and development, marketing and management are often motives
underlying such mergers.

(28) Vertical Merger

Vertical merger occurs when a firm acquires firms ‘upstream’ from it

and/or firms ‘downstream’ from it. In the case of an ‘upstream’ merger, it
extends to the firms supplying raw materials and to those firms that sell
eventually to the consumer in the event of a ‘downstream’ merger. Thus, the
combination involves two or more stages of production or distribution that are
usually separate. Lower buying cost of materials, lower distribution costs,
assured supplies and market, increasing or creating barriers to entry for
potential competitors or placing them at a cost disadvantage are the chief gains
accruing from such mergers.

(29) Conglomerate Merger

Conglomerate merger is a combination in which a firm established in one

industry combines with a firm from an unrelated industry. In other words, firms
engaged in two different/ unrelated economic/business activities combine
together. Diversification of risk constitutes the rationale for such mergers.

(30) Ordinary Share Financing

When a company is considering the use of common (ordinary) shares to

finance a merger, the relative price-earnings (P/E) ratios of two firms are an
important consideration. For instance, for a firm having a high P/E ratio, ordinary
shares represent an ideal method for financing mergers and acquisitions.
Similarly, ordinary shares are more advantageous for both companies when the
firm to be acquired has a low P/E ratio.

(31) Deferred Payment Plan

Under this method, the acquiring firm, besides making an initial payment,
also undertakes to make additional payments in future years to the target firm in
the event of the former being able to increase earnings consequent to the
merger. Since the future payment is linked to the firm’s earnings, this plan is
also known as earn-out plan.

(32) Tender Offer

An alternative approach to acquire another firm is the tender offer. A

tender offer, as a method of acquiring a firm, involves a bid by the acquiring firm
for controlling interest in the acquired firm. The essence of this approach is that
the purchaser approaches the shareholders of the firm rather than the
management to encourage them to sell their shares generally at premium over
the current market price.

(33) Free –Cash Flows

Free cash flows are after-tax operating earnings from acquisition plus non-
cash expenses applicable to the target firm less expected additional investments
in long-term assets and working capital.

(34) Adjusted Present Value

It is the value of the target company if it were entirely financed by equity

plus the value of the impact of debt financing in terms of the tax benefits as well
as bankruptcy cost.

(35) Net Present Value

The net present value of a project is the sum of the present values of all
the cash flows (positive as well as negative) that are expected to occur over the
life of the project.

(36) Benefit Cost Ratio

It is defined as the present value of benefits (cash inflows) divided by the

present value of costs (cash outflows). A project is considered worthwhile if the
benefit cost ratio is more than 1 and not worthwhile if the benefit cost ratio is
less than 1.

(37) Internal Rate of Return

The internal rate of return of a project is the discount rate which makes its
NPV equal to zero. In the NPV calculation we assume that the discount rate is
known and determine the NPV. In the IRR calculation, we set the NPV equal to
zero and determine the discount rate that satisfies this condition.
(38) Payback period

It is the length of time required to recover the initial cash outlay on the
project.

(39) Accounting rate of return

It is also referred to as the average rate of return on investment, and is a

measure of profitability which relates income to investment, both measured in
accounting terms.

(40) Initial Public Offering

The first public offering of equity shares of a company, which is followed

by a listing of its shares on the market, is called an initial public offering.

(41) Authorised Capital

The amount of capital that a company can potentially issue, as per its
memorandum, represents the authorised capital.

(42) Cumulative and Non-cumulative Preference Shares

Cumulative preference shares entitle the shareholders to receive

dividends for previous years in which dividend was not paid. A company cannot
declare equity dividends unless dividends on cumulative preference shares are
paid with arrears.

(43) Participating and Non-participating Preference Shares

The holders of participating preference shares get a share in the profits of

the company after a certain rate of dividend is paid to the equity shareholders of
the company. This is in addition to the fixed rate of dividend declared on
preference shares before any equity dividend is paid. The holders of Non-
participating preference shares can get only a fixed dividend and do not get any
share in the surplus left after paying equity dividend.

(44) Redeemable and Non-redeemable Preference Shares

Redeemable preference shares are repayable at par or at premium after a

specified period. Non-redeemable preference shares are not repayable, except
when the company goes into liquidation. In India the redemption period do not
exceed twenty years.

(45) Convertible and Non-convertible Preference Shares

Convertible preference shares can be converted into equity shares at the

option of the preference shareholders in accordance with certain predetermined
terms. Non-convertible shares do not carry such an option.

(46) Deep Discount Bond

 A deep discount bond does not carry any coupon rate but is issued at a
steep discount over its face value. It is also referred to as a zero interest coupon
bond.

(47) Convertible Debentures

A convertible debenture is a debenture that is convertible, partially or

wholly, into equity shares. These are of two types Fully Convertible Debentures
(FCB) and Partially Convertible Debentures (PCB).

(48) Floating Rate Bonds

Conventional bonds carry a fixed rate of interest. Floating rate bonds, on

the other hand, earn an interest rate that is linked to a benchmark rate such as
the Treasury bill interest rate.

(49) Indexed Bonds

The payoff of a typical indexed bond consists of two parts. The first part
represents a fixed amount and the second part represents a variable component
whose value is dependent on some index.

(50) Private Placement

A private placement is an issue of securities to a select group of persons

not exceeding 49.

(51) Preferential Allotment

When a listed company issues shares or debentures to a select group of

persons in terms of the provisions of Chapter XIII of SEBI Guidelines, it is referred
to as a private placement. The issuer has to comply with various provisions,
relating to pricing, disclosures, lock-in period and so on.

(52) Financial Closure

It means that all the sources of funds required for the project have been
tied up.

(53) Call Market

A market in which trading for individual stocks only takes place at

specified times. All the bids and asks available at the time are combined and the
market administrators specify a single price that will possibly clear the market at
that time.

(54) Commission brokers

Employees of a member firm who buy or sell securities for the customers
of the firm.

(55) Contrarian
 It is an investment strategy that attempts to buy (sell) securities on which
the majority of other investors are bearish (bullish).

(56) Fiduciary

A person who supervises or oversees the investment portfolio of a third

party, such as in a trust account, and makes investment decisions in accordance
with the owner’s wishes is known as fiduciary.

(57) January Effect

It is a frequent empirical anomaly where risk-adjusted stock returns in the month

of January are significantly larger than those occurring in any other month of the
year.

(58) Real Estate Investment Trusts (REITs)

Investment funds that hold portfolios of real estate investments.

(59) Trough

The culmination of a bear market at which prices stop declining and begin
rising.

(60) Value Stocks

Value stocks are the stocks that appear to be undervalued for reasons
besides earnings growth potential. These stocks are usually identified based on
high dividend yields, low P/E ratios, or low price-to-book ratios.