INSTRUCT US MARKETS n avigating the financial world - PowerPoint Presentation

Slide1

INSTRUCT

US MARKETS

n

avigating the financial world

INTRODUCTION

TO CAPITAL MARKETS AND INVESTMENT BANKINGSlide2

Giles began his career on the Stock Exchange floor at Big Bang in 1986, trading for Nat-West markets.

Following this he joined Deutsche Bank and then Citigroup where he was Managing Director responsible for Energy trading.

Alongside his main function as a senior equities trader, Giles has also had responsibility managing the relationship between markets and corporates.

Giles has been a regular speaker at the Citi

Investor Relations University and has delivered many successful corporate pitches.

Giles

johnstonSlide3

Graham began his career as a trader at Smith Barney

in 1996

before joining Citigroup as managing director

of European

Trading and subsequently Unicredit as Global Head

of Trading and Sales Trading.Graham was promoted to Managing Director at the age of 30, running a team of 50 and

a trading portfolio of $3bn.As well as delivering Instructus training courses in Capital Markets and Trading, Graham also runs a Pan-European fund for Trafalgar Capital, a global hedge fund.

Graham SmithSlide4

Terminology

Role and function of capital markets

Introduction to asset classes

Buy side and sell side activities

Investment Bank divisions

Roles within investment bank Operations Regulation and compliance

AgendaSlide5

Capital marketsSlide6

what are capital markets?Capital markets exist to allow companies to raise money by selling a part of their business to investors (equities) or to borrow money, through issuing debt (bonds)A market where a government can raise money (capital) to fund their operations.

The initial stage of raising this capital is called the primary market, prior to listing on an exchange The subsequent trading of these bonds or equities is known as the secondary marketModern day integrated investment banks are involved in both the primary and secondary marketsSlide7

The importance of capital marketsProvide an exit strategy for privately owned companies to realise their value

Provide an entry strategy for investors looking to benefit from a company’s growth and distribution of earnings Pension and investment funds receive an income through dividends, bond yields and capital appreciation, allowing them to pay pension holdersSlide8

Terminology Basis points:

1% is 100 basis points OTC: Over the counter: display prices but no firm commitment. Most bond markets Order driven market: where buyers and sellers display prices at which they would buy and sell assets Short position: Selling an asset that you don’t already own.

Primary: Capital raising Secondary:

Trading of listed assets IPO: Initial Public Offering, the listing of securities, selling to institutions and the public

ECM: Equity Capital Markets

DCM: Debt Capital MarketsSlide9

Order driven market

Source BloombergSlide10

Recent stock market history:

Traditionally, jobbers and market makers were the point of execution

Clients were obligated to place orders through brokers

Clients were predominantly pension funds, insurance companies and professional institutional investors

“Big Bang” in 1986 gave birth to the modern market: market makers, brokers and merchant banks merged into integrated investment banks

INTRODUCTION TO FINANCIAL MARKETSSlide11

Recent stock market history:

Significant capital injections

catalysed

explosive growth in trading volumes

Total levels of market risk rose exponentially

First stage of electronic trading allowed prices to be advertised on screens across banks

Early 1990’s market became order driven (spreads narrowed sharply) Investment banking margins therefore declined (volumes increased dramatically) Late 2000’s, direct market access offered to buy side clients

INTRODUCTION TO FINANCIAL MARKETSSlide12

The old stock exchange floorSlide13

Overview of the financial services industryKey participants of the primary market

Corporations: large and small, listed and unlisted companies Governments Asset managers/Private equity Advisory services of the investment banksSlide14

Overview of the financial services industryKey participants of the secondary markets

Asset managers (buy side) Pension funds Insurance firms Hedge funds Retail funds Investment funds

Private wealth management Private Equity Firms

Advisory and execution services (sell side) Investment banks

Brokers Slide15

Asset

classesSlide16

asset classes

Shares (Equities)

What are they?

Publicly listed companies traded on an exchange

Most listed shares traded via order driven market

Many pay dividends, FTSE 100 yields about 3.5%

Investment banks subdivide the market by market

capitalisation

Specific funds for smaller companies

Companies become public via an IPO (Facebook, Twitter and Royal Mail)

Twitter shares issued at $26, trade at $45 on first day of trading

This year has seen the largest number of IPO’s in the US since 2007

Free float is the percentage of shares floated at an IPO

Not necessarily listed in home market (Prada and

Alibaba

)

ADR’s (American Depositary Receipts)

LiquiditySlide17

Traded volume in a liquid stock

Source BloombergSlide18

Traded volume in an illiquid stock

Source BloombergSlide19

Volatility of a liquid stock

Source BloombergSlide20

Volatility of an illiquid stock

Source BloombergSlide21

Index weighting

Primary weightingsFTSE= miners, oil and gas, financialsDAX

= Industrials, consumers, financialsS&P= Tech but broad basedSlide22

asset

classes

Foreign Exchange

Currencies of countries

Traded in pairs, one against another

No income

Multinational companies hedge their currency exposure

Represents prospects of one country’s economy compared with another

Central bank intervention in FX markets (most recently Japan)

Currencies often affect the price of commodities

Each currency has its own risk profile

Highly liquid market, open 24hrs a day (apart from weekends)

Average daily volume is $5 trillionSlide23

GBP/USD

Source BloombergSlide24

asset

classes

Commodities

Either Hard (gold, silver, copper, oil)

Or

Soft

(tea, coffee, cocoa, sugar

)

Prices driven by supply and demand, and speculation

Trade in contracts, usually one month and lot size, e.g. 1 lot

=

1000 barrels

Gold is seen a hedge against inflation and a safe haven

Iron ore and copper: Industrial metals, affected by global growth

Oil can move on geopolitical factors and economic outlook as well as supply and demand, however US shale gas boom has had a significant impact on volatility

Armajaro

, recently sold to

Ecom

(soft) and

Glencore

Xstrata are two of the biggest participants. Slide25

asset classes: Gold

Commodities

Either Hard (gold, silver, copper, oil)

Or

Soft

(tea, coffee, cocoa, sugar

)

Tea prices have fallen 35% this year on bumper crop and Egyptian crisis

Prices driven by supply and demand, speculation and weather

Trade in contracts, usually one month and lot size, e.g. 1 lot

=

1000 barrels

Gold is seen a hedge against inflation and a safe haven

The cost of producing a troy ounce is $1200 for some miners

Iron ore and copper: Industrial metals, affected by global growth

Oil moves on political tension in Middle East as well as speculation and demand

Along with the major investment banks,

Armajaro

(soft) and

Glencore

Xstrata are two of the biggest participants. Slide26

Brent crude oil 1 year graph Source BloombergSlide27

asset

classes

Commodities

Physical operators, such as airlines, use commodity derivatives to hedge their exposure

Traditionally these derivatives were sold by investment banks

Post the financial crisis and the capital constraints some banks have pulled away from offering derivative hedges

Oil groups and utility companies have filled the gap. In 2008 oil and utility companies had approximately 5% market share, that has now grown to between 25% and 33%Slide28

asset

classes

Bonds (also known as Credit, Debt or Fixed income)

A debt issued with a fixed return (coupon) to the lender

Corporate or Sovereign (50-50 by value)

Predominantly traded OTC (US accounting for about 50%)

Goldman Sachs developing electronic trading platform

Yield of a bond represents the cost of borrowing (terms 1, 3, 5 and 10 years)

Higher the yield, the more expensive it is to borrow

Yield indicates the risk associated with that bond (higher yield, higher risk)

Yield moves inversely to the price of a bondSlide29

asset

classes

Bonds (also known as Credit, Debt or Fixed income)

Inverse

relationship between bond valuations and interest

rates

Allows corporates and sovereigns to ‘lock in’ interest rates for a defined period

We have seen a rush by US corporations to issue bonds ahead of possible Fed tapering

Verizon raises $50bn in bond market

Some countries have very high yields (Spain 10yr was at over 7% now 2.5%)

Safe haven countries are at record lows (German 10yr bund 0.9%)

Pimco

and Vanguard are two of the largest investors in bonds

Deutsche Bank is ranked Number 1 in fixed incomeSlide30

Spanish 10yr bond yield vs eurostoxx

50Source BloombergSlide31

asset

classes

Bond ratings

Three main companies rate sovereign and corporate bonds:

Moody’s

S&P (Standard and Poor’s)

Fitch

Rated from AAA (highest) to junk status (BBB-)

Each rating helps determine the level of risk associated with a bond

Highly rated bonds (AAA) will have the lowest yield and vice versa

Only four US companies have AAA, Microsoft, J&J, Exxon and ADP

Rating firms can also give an outlook that suggests which way the rating may move:

Positive, stable, negativeSlide32

asset

classes

ETF’s, CDO’s, and CDS’s

Exchange Traded Funds

: A security that tracks an index, a commodity or a basket of assets

Collateralised

Debt Obligation

: An asset backed security, usually backed by a collection of bonds, loans and other assets. Trades in tranches which will have different risk profiles and have coupons that represent that risk profile.

Credit Default Swaps

: Insurance against non-payment on a fixed income product. The buyer of the swap pays to protect against default, the seller of the swap pays out in the event of defaultSlide33

Buy side and sell side functionsSlide34

Buy Side

Investment Funds (focused on specific regions, sectors, designated risk profile: Fidelity)

Pension Funds (long term, low risk, income generating: British Airways Pension Fund)

Quantitative funds: investment decision based on computer modeling

Hedge Funds (shorter term, higher risk, highly leveraged portfolio trading: Moore Capital)

Private wealth management (broad based investment of private clients money) Most of the above have their own dealers Historically longer term and long only investors Receive fees according to AUM (1-2% management fee) Clients have a mandate (suggests risk profile of the client’s investments)

Buy side pays for services of the sell side, on an unbundled basis

Buy side

&

sell sideSlide35

Sell Side

Investment Banks and brokers (Goldman, JP Morgan,

Numis

)

Gateways to the market (execute orders on behalf of the buy side)

Commissions paid for research advice, distribution and execution services Traders execute orders from buy side institutions (agency or risk)

Capital Markets (IPO’s, Rights Issues, Placings) Trading/research/sales (in bonds, equities, commodities or FX) Deal with institutional clients (Fidelity, Legal & General, Moore Capital)

Buy side

&

sell sideSlide36

Technology

And InvestingSlide37

asset

classes

High Frequency Trading

Sophisticated computer technology using algorithms to trade securities at very high speed and volume

Proprietary trading strategies

US is the biggest market for HFT with Asian markets the smallest.

Very rapid turnover with positions often held for seconds

Highly active at times of rebalancing

No open positions at the end of the trading session

Arms race for fastest and closest computer (to exchange)

Debate as to the merits of HFT, distortion of volume

or improved liquidity

France is moving to ban HFT post ‘flash crash’ in the US

Italy introduces tax on HFT (2

nd

September)

Talk of ‘speed limits’ to make a more level playing fieldSlide38

Algorithmic Trading

Advanced computer programs that execute orders automatically, following predetermined instructions

Over 90% of all trading is transacted through a computer algorithm

Smart order routers designed to have market beating performance

Still requires human input and monitoring

Program trading makes up about 30% of the NYSE daily volume

Many strategies including Volume Weighted Average Price (VWAP), Time Weighted Average Price (TWAP) and percentage of volume (POV)Constantly updating and improving to try and prevent ‘gaming’

technologySlide39

technology

Dark Pools

Dark pools: Hidden liquidity usually traded off exchange through crossing networks

Originally designed for the anonymous trading of large blocks of stock between institutions

Dark liquidity now makes up approximately 7% of total volume

Average trade size now only 200 shares

Several exchanges are trying to limit the amount of business transacted in dark pools

Hidden liquidity on exchange: Iceberg orders that show only a small percentage of the total order and hidden ordersSlide40

Direct Market Access: DMA

The ability of buy side dealers to access the market through a sell side firm’s trading platform without any direct contact,

eg

. Blackrock using Citi’s systems.

Nomura bought Instinet in 2006 opening the way for buy side firms to be able to work their own orders rather than relying on the investment banks to trade for them

The client still pays the sell side a commission for using their technology, but at a vastly reduced rate

There are numerous advantages for the buy side institutions:Cost of executionSpeed of executionAnonymity

Buy side technologySlide41

Investment bank

Divisions Slide42

Investment Bank Divisions

Two Principal Activities: Primary and Secondary

Capital markets, corporate advisory and mergers and acquisitions

Fees are usually paid on a deal basis as a percentage of value (some clients pay a retainer)

Markets division, research, sales and trading

Revenue generated through commission and trading (some clients will pay for research by

cheque

)Slide43

Investment Bank Divisions

Capital Markets: Primary

Capital markets split into both equity and debt (ECM & DCM)

Provide advice and product solutions for equity and debt capital raising;

IPO’s

Bond issues

Capital Increases (Rights issues)

Convertible bonds

Private placements (Barclays)Slide44

Investment Bank Divisions

Capital Markets: Primary

Initial Public Offering (IPO)

Senior management of the corporate (for example

Moncler

and their private equity partners) meet with Capital Markets teams

Ensure

underwriting firms are in place (syndicate of banks

)

Liaise with bank’s sales team and buy side community to determine demand (roadshows) Allocate those shares to clients at the issue price Speak with traders responsible for the Green ShoeSlide45

Investment Bank DivisionsSlide46

Investment Bank Divisions

Capital Markets: Primary

S

econdary

listings (Rights Issues

)

Issuance of new shares to existing shareholders

Shareholders have the right but not the obligation to take up the rights Rights are offered to existing shareholders on a pro rata basis (i.e. 2:1) Underwriters in place Convertible Bonds Issuing debt in the form of a bond (raise capital) Bonds are convertible to stock (equity) at a predetermined price Offers a coupon of lower yield as risk is lessened by its convertible nature

Cheap way of raising finance for the issuerSlide47

Investment Bank Divisions

Capital raising by Barclays

£5.8 billion rights issue

£2 billion convertible bond

Fourth largest rights issue by a UK bank

Terms of issue: 1 for 4 at £1.85 (40% discount to closing price)

To strengthen their balance sheet in line with Prudential Regulation Authority stipulations

£12.8 billion shortfall

Cutting assets by £60-80 billion

Four investment banks handling the issue: Citi, Deutsche Bank, Credit Suisse and Bank of America Merrill Lynch Slide48

Investment Bank Divisions

Advisory Departments:

Corporate finance

:

Raising and managing financing for bank’s corporate clients

Budgeting and financing new projects and developments (large capital intensive projects)

Funded either through debt or equity (ECM or DCM involved)

Both long and short term focused (cash, projects, dividends, debt refinancing

etc

) Helps maintain a relationship between the bank and its corporate clientsSlide49

Investment Bank Divisions

Advisory Departments:

M&A

:

Responsible for the merger or takeover process between two corporate parties: for example Pfizer’s approach to AstraZeneca (tax inversion deal)

Most recent UK approach is Microchip (US) for CSR (UK)

Work with corporate finance to manage the funding of this process

Funding either through cash, equity or debt

Undertake high level of due diligence (nb:Autonomy and Hewlett Packard) Last week $100bn of deals fell through (huge loss of fees) Work behind Chinese Wall from other departments Party to price sensitive informationSlide50

Chinese wallsSlide51

Importance of Chinese walls A virtual and sometimes physical barrier between departments Used to prevent the dissemination of price sensitive information within a firm

Is a criminal act to pass on or knowingly act on price sensitive information How do you determine what is and isn’t price sensitive information? To which departments is this most relevant?Steve Cohen of SAC partners fined $1.8bn and banned from managing external investments after pleading guilty to insider trading, possible criminal case to follow.Slide52

Investment Bank Divisions

Advisory Departments:

Corporate finance

:

Vodafone to sell it’s Verizon stake for $130bn

The transaction will be the 3

rd

largest M&A deal ever

Most of the proceeds to be returned to shareholders Verizon’s bankers, including JP Morgan, Morgan Stanley and BoA Merrill Lynch are set to underwrite over $60bn in debt to finance the deal The disposal will be largely tax free as it involves selling a stake in a US domestic to a domestic buyerSlide53

Prime brokerage

Investment bank (sell side) service to Hedge Funds (buy side)

Prime

Broker holds

positions (shares)

on behalf of the

client

Usually trades

via CFD (Contract for Difference

) Tax efficient means of operating Provide centralised clearing facility Provide the opportunity to borrow stock (to fulfill obligations on short positions) Offer access to leverage Can offer a sales trading service to their clients (market advice and insight)Slide54

Research

Analysing

companies within sectors and regions

Large reliance on models within research coverage

Provide a recommendation on assets covered (buy, hold, sell)

All published material is vetted by compliance Research analysts ranked by external surveys of clients (Extel

)

CFA exam a likely requisite for an analyst role

Sales & Specialist Research Sales Generalist sales people will market all ideas to clients Specialist sales promote specific sectors All sales executives tailor research advice to meet client needs

Roles within capital marketsSlide55

Rio analyst recommendations

Source BloombergSlide56

Sales Trading

Provide

timely and pertinent information, ideas, advice and support to

clients

Speak to the dealing desk of the client

Backing

of the banks capital base

Close working relationship with sales and trading

Source liquidityTrading Agency and Market Making Proprietary and Special Situation Trading AE, Algorithm, Program Trading Liquidity, risk management and commission retention

Roles within capital markets Slide57

Delta 1

Delta 1 products are a type of derivative

These products move in a very similar way to the underlying asset (almost exactly)

The SPDR (know as spider) is an EFT of the S&P index

Structured products that can be

customised

to suit client needs

Use fairly large amounts of capital but generally profitable

HFT active in this area Enable banks to take risk (not bound by the same regulation as the rest of trading) High prolife losses such as at UBS and Soc Gen

Roles within capital markets Slide58

Private equity

& venture capitalSlide59

roles within Finance: Private equityPrivate equity firms raise funds to acquire a controlling or substantial stake in a company, then look to maximize the value of that investment.

Will usually have a spread of investments to mitigate risk.They will receive a management fee and also a percentage of any profitsValue can be created in various ways;Change the strategy: strengthen the management team

Capital expenditure/investmentLowering the cost of capital

Growth through mergers and acquisitionsSlide60

roles within Finance: Private equityPrivate equity investments are long term (usually at least 5 years)

Exit strategiesInitial Public Offering (Eurozeo sells half its stake in Moncler at float)Trade sale (M&A) either for cash or equity in acquirer ( 65% of deals in 2012)Recapitalisation

: Pay cash distribution from cash flow or raise debt to finance distribution

The largest private equity firms include:

TPG The Carlyle Group Blackstone

Silver Lake (recently part of the Dell deal) KKR

Terra Firma (European)Slide61

roles within Finance: venture capitalVenture capital firms are similar to private equity but usually invest at an earlier stage of a company’s development and don’

t necessarily have a controlling stake or board representation.A broad spread of investments as early stage investment does have a high failure rate.VC’s are frequently providers of seed funding to early-stage firms (which might struggle to raise capital elsewhere)Invest cash in exchange for an equity stake

Exit strategy is usually through trade sale or IPOSummly bought by Yahoo for $30mnSlide62

operationsSlide63

Roles WITHIN OPERATIONS

Operations: middle office (usually based on the trading floor)

Confirmation of order execution

Allocation of assets to client funds

Price and quantity reconciliation

Confirmation with client T+1 (1 day)

Maintaining detailed records of transactions

Corporate

action: dividends, rights issues, share consolidation, buy-

ins

Relationship management with trading counterparts

Ensuring the integrity of the bank’s trading positions and P&LSlide64

Roles WITHIN OPERATIONS

Operations: middle office

Liaise with the banks treasury department to ensure sufficient funding is available for warehoused positions and trading inventory

In an era of contraction of commission revenue it is vital that middle office operations are as efficient as possible

Recently we have seen many buy side institutions merge their fixed income and equities middle office operations Slide65

Life cycle of a tradeSlide66

Roles within OPERATIONS

Compliance

The role of the compliance department is protect the firm and employees against breaches of codes and ethics, covering topics such as:

KYC: ‘Know Your Customer’

Bribery Act

Anti-money laundering legislation

Market abuse

Conflict of interest

Insider trading

With increased levels of regulation compliance is one of the fastest growing divisions within the financial services sector.Slide67

Think smart : Outside the box

Consider smaller investment banks and brokers

Macquarie: Provides advice, capital raising, fund management, research, sales and trading (Australian)

Mirabaud

: Similar services to the above. Based in London, with Swiss parent.

Brewin

Dolphin: One of the UK’s largest independent private client stockbrokers with £26bn under management and 40 UK offices.

Numis

: A leading small and mid cap institutional stockbroker based in London and New York.

Redburn

: Europe’s largest independent equities broker, producing conflict-free institutional research.Slide68

Think smart : Outside the box

Global Transaction Services (within investment banks)

Strategic advice on custody, settlement, securities infrastructure and emerging markets

White label products used by other financial institutions

Fast growing business (Citi has 22,000 employees in 100 countries)

Very profitable

Can be used as stepping stone (Tom)Slide69

RegulationHighly regulated environment Basel III (capital requirements)

Dodd Frank Volcker Rule (Proprietary trading) Financial Transaction Tax (since its introduction in March Italy has seen a significant reduction in trading volume on its exchange)Increasing political and regulatory intervention within the industry to mitigate risk of bank failureSlide70

Think smart : Outside the box

Technology

Technology plays such a vital role with financial services

Constantly evolving and improving

Part of the front office infrastructure

Many senior executives have progressed from IT rolesSlide71

Think smart : Outside the box

Maximise

your chances by considering large companies outside finance

Big corporations with foreign exchange flows and borrowing requirements

Big enough to have a treasury department. This department will be responsible for lines of credit, bond issuance and foreign exchange trading

For example truly international companies: BP, Royal Dutch Shell,

Inditex

, Vodafone, BASF, BMW

Most large European listed companies. Slide72

Think smart : Outside the box

European Merger and Acquisitions

US Investment banks dominate the largest transactions, leading firms include JP Morgan, Morgan Stanley and Goldman Sachs

Smaller deals of $500m and under are less dominated by the investment banks. Consultants firms PwC and KPMG and merchant banks such as Rothschild are very active in this area

Slide73

The

Future of the industrySlide74

the future With new technology and the failures of risk management being the biggest themes of the past decade, what will be the next chapter in the permanent revolution? Corporate activity and M&A

IPO market Return of leveraged buyouts and private equity deals Asset managers fees Banks risk profile/liquidity

Bond markets becoming order driven Regulation

Expansion of graduate programs back to pre crisis levelsSlide75

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