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Tài liệu Investment banking

Business & Economics/Banks & Banking

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Want to expand your knowledge or learn what you need
to know to ace your investment banking course? This in-depth
guide takes a comprehensive approach to the topic
of investment banking so you can discover everything
you’ll need to know to apply your knowledge in the
real world.

•Get started with investment banking — find out what
investment bankers do and how they facilitate financing,
mergers, and acquisitions
•Dig in — discover the hidden truth in financial statements,
where to find and read the reports you’ll need, and how to
perform industry analysis
•Take it to the next level — dig into the details of discounted cash
flow analysis, structuring a leveraged buyout, and determining
return on equity
•Apply investment banking — understand the past of investment
banking and new regulations that define the rules of the game
•Fill your tool box — discover the best online resources for
investment bankers, ways to improve your analysis, and other
important tools and tips

Matt Krantz is the stock market and IPO reporter for USA TODAY,
covering financial markets and Wall Street. Robert R. Johnson,
PhD, CFA, CAIA, is a Professor of Finance at Creighton University,
where he teaches in the Master of Security Analysis and Portfolio
Management Program.

Open the book and find:
•What investment banking is
and how it works
•The role of investment bankers
in mergers and acquisitions
•How to use important corporate
filing documents
•The uses of financial statements
•Details on performing
discounted cash flow analysis
•A thorough overview of fixed
income
•How to determine a company’s
return on equity
•Case studies to help reinforce
your reading

Investment Banking


The keys you need to know
about investment banking

Cover Image: ©iStockphoto.com/Danil Melekhin

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Learn to:

•Grasp and apply the fundamentals of
investment banking
•Understand post-financial
crisis changes

Go to Dummies.com®

•Score higher in your investment
banking course

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$26.99 USA / $31.99 CAN / £19.99 UK

Matthew Krantz

ISBN:978-1-118-61577-5
52699

9 781118 615775

Author of Investing Online For Dummies

Krantz
Johnson

Robert R. Johnson, PhD,
CFA, CAIA
Professor of Finance, Creighton University


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Investment
Banking

by Matthew Krantz
and
Robert R. Johnson, PhD, CFA, CAIA


Investment Banking For Dummies®
Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com
Copyright © 2014 by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
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­ ermitted
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Library of Congress Control Number: 2013954075
ISBN 978-1-118-61577-5 (pbk); ISBN 978-1-118-61570-6 (ebk); ISBN 978-1-118-61571-3 (ebk);
ISBN 978-1-118-61588-1 (ebk)
Manufactured in the United States of America
10 9 8 7 6 5 4 3 2 1


Contents at a Glance
Introduction................................................................. 1
Part I: Getting Started with Investment Banking............. 5
Chapter 1: Introducing Investment Banking.................................................................... 7
Chapter 2: The Purpose of Investment Banking: What Investment Bankers Do...... 23
Chapter 3: How Investment Bankers Sell Companies.................................................. 43
Chapter 4: How Investment Banking Is Used in Mergers and Acquisitions.............. 61
Chapter 5: How Investment Banking Is Used in Leveraged Buyouts......................... 79

Part II: Digging In: Performing Investment Banking...... 93
Chapter 6: Finding the Data: Documents and Reports................................................. 95
Chapter 7: Making Sense of Financial Statements...................................................... 113
Chapter 8: Perfecting the Financial Ratios for Investment Banking......................... 133
Chapter 9: Sizing Up the Industry................................................................................. 151
Chapter 10: Understanding Stocks and Focusing on Past Transactions................. 169
Chapter 11: Applying Investment Banking to Fixed Income..................................... 183

Part III: Taking Investment Banking to the Next Level....201
Chapter 12: Doing a Discounted Free Cash Flow Analysis........................................ 203
Chapter 13: Structuring a Leveraged Buyout.............................................................. 223
Chapter 14: Determining the Strength of a Company’s Return on Equity............... 237

Part IV: Applying Investment Banking....................... 253
Chapter 15: Knowing the Rules..................................................................................... 255
Chapter 16: Seeing How Some Companies Lie, Cheat, and Steal
Their Way to the Top................................................................................................... 269
Chapter 17: Understanding Alternative Investments and Asset Management....... 289
Chapter 18: Trying Your Hand at Investment Banking with a Case Study.............. 303

Part V: The Part of Tens............................................ 315
Chapter 19: Ten of the Biggest Debacles in Investment Banking History............... 317
Chapter 20: Ten Ways to Improve a Discounted Cash Flow Analysis...................... 325
Chapter 21: Ten (Or So) of the Best Online Resources for Investment Bankers....... 333

Appendix: Where Investment Banking Came From....... 341
Index....................................................................... 349



Table of Contents
Introduction.................................................................. 1
About This Book............................................................................................... 1
Foolish Assumptions........................................................................................ 3
Icons Used in This Book.................................................................................. 3
Beyond the Book.............................................................................................. 4
Where to Go from Here.................................................................................... 4

Part I: Getting Started with Investment Banking............. 5
Chapter 1: Introducing Investment Banking. . . . . . . . . . . . . . . . . . . . . . . . 7
What Investment Banking Is............................................................................ 8
The role investment banking plays...................................................... 8
How investment banking differs from ­traditional banking.............. 10
The services investment banks provide............................................ 11
How investment banks are organized................................................ 12
The current lay of the investment banking land............................... 14
Types of investment banking operations.......................................... 15
How investment banks get paid.......................................................... 15
How Investment Banking Is Done................................................................. 17
Finding the financial statements......................................................... 17
Understanding the importance of financial statements
and ratios.......................................................................................... 18
Zeroing in on past transactions.......................................................... 18
Seeing the value of fixed income........................................................ 19
Turning Into an Investment Banking Pro..................................................... 19
Putting the discounted cash flow analysis to work.......................... 19
Seeing how leverage becomes a force in investment banking........ 20
Pinpointing buyout targets.................................................................. 20
Putting Investment Banking to Work........................................................... 21
Staying in compliance with the rules................................................. 21
Looking beyond the published financial statements....................... 21
Making adjustments to financial statements for
comparability.................................................................................... 22

Chapter 2: The Purpose of Investment Banking:
What Investment Bankers Do. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Putting the For-Sale Sign on Corporate America........................................ 24
Mergers and acquisitions.................................................................... 25
Leveraged buyouts............................................................................... 28
Private business sales.......................................................................... 30
Initial public offerings.......................................................................... 32


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Investment Banking For Dummies
Helping Investors Decide Whether to Buy or Sell...................................... 36
The importance of research................................................................ 36
What do the analysts do?.................................................................... 37
Digging Into the Role of the Trading Desk................................................... 38
Why investment banks are into trading............................................. 39
How investment banks turn pennies into billions............................ 40
The type of analysis used in trading ­operations.............................. 41

Chapter 3: How Investment Bankers Sell Companies . . . . . . . . . . . . . . 43
Getting Companies Ready for Sale on Public Markets............................... 44
Meeting the requirements to make an IPO happen.......................... 45
Writing the prospectus........................................................................ 47
Supporting the IPO: Making success last........................................... 51
Seeing What Sell-Side Analysts Do............................................................... 53
The goals of the sell-side analyst........................................................ 53
What investors look to sell-side analysts for.................................... 54
Spreading the word: Disseminating ­sell-side research.................... 55
Examining a Sample Research Report......................................................... 56
What to look for in the document....................................................... 56
The main sections of a research report............................................. 57
Ways to look beyond the “buy” or “sell”........................................... 59

Chapter 4: How Investment Banking Is Used in Mergers
and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Come Here Often? The Basics of Mergers and Acquisitions..................... 61
Kinds of mergers................................................................................... 62
Why companies merge instead of simply growing
organically.......................................................................................... 63
Firms that make attractive acquisition targets................................. 66
How companies identify firms to merge with................................... 67
The nature of the merger: Friendly or hostile?................................. 68
Tools Used to Analyze the M&A Deal.......................................................... 71
The role of the buy-side M&A advisor............................................... 71
The role of the sell-side M&A advisor................................................ 74
Why Many M&A Deals Go Wrong................................................................. 75
Misplaced incentives............................................................................ 75
Faulty analysis....................................................................................... 76
Overstated synergies........................................................................... 77
Culture wars.......................................................................................... 77
The winner’s curse: Overpaying......................................................... 78

Chapter 5: How Investment Banking Is Used
in Leveraged Buyouts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
In This Corner: Introducing the Players...................................................... 80
Investment banks.................................................................................. 81
Big institutions...................................................................................... 82


Table of Contents
Management.......................................................................................... 83
Stock and bond investors.................................................................... 84
Aiming for the Right Targets in a Leveraged Buyout................................. 85
Identifying companies that can work in a leveraged buyout.......... 85
Appreciating the power of cash flow................................................. 87
Coming to terms with the return analysis: Internal
rate of return...................................................................................... 88
Finding the Exit............................................................................................... 90
Setting a target for exit in time............................................................ 90
Considering how the exit will happen................................................ 90

Part II: Digging In: Performing Investment Banking....... 93
Chapter 6: Finding the Data: Documents and Reports . . . . . . . . . . . . . . 95
Finding What You Need on the Securities and
Exchange Commission’s Website............................................................. 96
What types of information you can find............................................ 96
The key types of documents............................................................... 97
How to use EDGAR to pinpoint information...................................... 98
Getting Data in a Format You Can Work With.......................................... 103
Assembling the tools you need......................................................... 103
Importing financial information into Excel...................................... 105
Getting in tune with interactive data................................................ 106
Paying Attention to the Non-Financial Information.................................. 107
Monitoring news streams for investment banking ideas............... 107
Quickly processing information with aggregators......................... 109
Doing research on the key players in a deal................................... 111

Chapter 7: Making Sense of Financial Statements. . . . . . . . . . . . . . . . 113
Income Statements....................................................................................... 114
Locating the areas of interest to ­investment bankers................... 116
Tweaking the statement with different assumptions..................... 117
Finding investment banking opportunities..................................... 118
Balance Sheets.............................................................................................. 119
Finding your way around the key parts........................................... 120
Understanding a company’s financial strength.............................. 122
Locating pitfalls and opportunities.................................................. 124
Statement of Cash Flows.............................................................................. 124
Seeing why the cash flow statement is so important
in deal making.................................................................................. 125
Understanding the key parts of the document............................... 125
Calculating free cash flow.................................................................. 128
Proxy Statements.......................................................................................... 128
Learning about the key players in a deal......................................... 129
Identifying the management team’s incentives.............................. 130
Analyzing management pay packages.............................................. 131

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Investment Banking For Dummies
Chapter 8: Perfecting the Financial Ratios for
Investment Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133
Valuation Multiples: Assessing How Much the Company Is Worth....... 134
Investors’ favorite valuation tool: P/E ratio.................................... 134
Going old school with price-to-book................................................ 135
Putting a price on profitability.......................................................... 136
Liquidity Multiples: Checking Companies’ Staying Power...................... 138
Deciphering debt to equity................................................................ 139
Getting up to speed with the quick ratio......................................... 140
Interpreting interest coverage.......................................................... 140
Profitability Ratios: Seeing How a Company’s Bottom
Line Measures Up..................................................................................... 141
Why gross margin isn’t so gross after all........................................ 142
Income from continuing operations: Looking at
profit with a keen eye..................................................................... 142
Keying into profits with net margin.................................................. 143
Efficiency Ratios: Knowing How Well the Company Is
Using Investors’ Money............................................................................ 144
Finding out about return on assets.................................................. 145
Digging into return on capital........................................................... 146
Uncovering company secrets with return on equity..................... 148
Calculating a company’s growth rate............................................... 148

Chapter 9: Sizing Up the Industry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151
Performing an Industry Analysis................................................................ 152
Understanding why industry analysis is important....................... 152
Creating a comparison universe....................................................... 153
Adjusting the industry comparison universe.................................. 157
Unearthing Company Trends and Common sizing
the Financial Statements.......................................................................... 158
Comparing growth rates.................................................................... 158
Comparing leverage............................................................................ 161
Comparing various profit margins................................................... 162
Seeing How a Company Stacks Up: Comparing the Key Ratios.............. 164
Sizing up valuation.............................................................................. 164
Comparing total debt-to-equity......................................................... 167
Sizing up companies on their efficiency.......................................... 167
Industry ratios..................................................................................... 168

Chapter 10: Understanding Stocks and Focusing on
Past Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169
Introducing Stock......................................................................................... 170
Characteristics of stock..................................................................... 170
Types of stock..................................................................................... 172
Understanding stock pricing............................................................. 173


Table of Contents
Finding Past Transactions........................................................................... 174
Tracking the stock market................................................................. 174
Studying private deals........................................................................ 174
Looking at pre-IPO marketplaces...................................................... 176
Examining buyouts............................................................................. 176
Analyzing Past Transactions....................................................................... 177
Knowing what the market will bear.................................................. 177
Knowing when the market is distorted............................................ 178
Tabulating key ratios for past deals................................................. 179
Understanding the pitfalls................................................................. 182

Chapter 11: Applying Investment Banking to Fixed Income. . . . . . . . 183
Introducing Bonds........................................................................................ 184
Identifying the Various Types of Bonds.................................................... 186
Convertible bonds.............................................................................. 187
Callable bonds..................................................................................... 187
Puttable bonds.................................................................................... 187
Floating-rate bonds............................................................................. 187
Zero-coupon bonds............................................................................ 188
Knowing Their Place: The Position of Bondholders................................ 188
Understanding Bond Pricing....................................................................... 190
Introducing the concept of present value....................................... 190
Relating yield to maturity and price................................................. 193
Playing the spread: How different factors affect bond prices...... 194
Considering bond sensitivity to changes in interest rates............ 195
Tracking the Bond Market........................................................................... 198
Debt or Equity: How a Company Chooses................................................. 200

Part III: Taking Investment Banking to the Next Level...... 201
Chapter 12: Doing a Discounted Free Cash Flow Analysis . . . . . . . . . 203
Gearing Up for Discounted Free Cash Flow............................................... 204
Computing free cash flow.................................................................. 206
Forecasting free cash flow................................................................. 207
Calculating the Weighted Average Cost of Capital................................... 208
Understanding why the weighted average cost of
capital is so important.................................................................... 209
Measuring the cost of debt and equity............................................ 210
Understanding the capital asset pricing model.............................. 213
Going for Terminal Value............................................................................. 216
Knowing the perpetuity growth formula......................................... 216
Applying the constant growth formula............................................ 217
Applying the two-stage growth model............................................. 217
Stress-testing the results................................................................... 219
Valuing a Share of Stock.............................................................................. 220

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Investment Banking For Dummies
Chapter 13: Structuring a Leveraged Buyout . . . . . . . . . . . . . . . . . . . . . 223
Seeing How Leveraged Buyouts Are Structured....................................... 224
The types of financing........................................................................ 224
Understanding seniority and maturity............................................. 230
Building a Leveraged Buyout Model.......................................................... 231
Creating a pro forma model.............................................................. 232
Deciding on methods of financing.................................................... 233
Seeing how the results work out....................................................... 234
The importance of taxes in a leveraged buyout............................. 235
What can go right and what can go wrong...................................... 235

Chapter 14: Determining the Strength of a Company’s
Return on Equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237
Understanding the Importance of Return on Equity................................ 238
What return on equity shows............................................................ 239
Pros and cons of return on equity versus other
profitability measures.................................................................... 241
How return on equity can help guide an investment
banking deal..................................................................................... 244
Using a DuPont Analysis.............................................................................. 244
The three-factor DuPont method...................................................... 245
The five-factor DuPont method......................................................... 247
Interpreting the Results............................................................................... 249
Cola wars............................................................................................. 249
What the numbers mean.................................................................... 250
Looking past the numbers for insight.............................................. 251
Telling companies how to react to the numbers............................ 251

Part IV: Applying Investment Banking........................ 253
Chapter 15: Knowing the Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255
The History of Regulation of Investment Banking.................................... 255
The goals of investment banking regulation................................... 256
Why the rules of today are the result of days past........................ 256
How regulations have shaped the investment
banking industry............................................................................. 256
The Ins and Outs of Modern Investment Banking Rules......................... 258
The types of rules imposed on investment banking...................... 258
How investment banking rules changed after the
financial crisis.................................................................................. 261
The Rules on Analysts.................................................................................. 263
Why rules were needed...................................................................... 263
The not-so-delicate balancing act analysts play............................. 264
What disclosure and compliance are required............................... 265
Why Simply Making Rules Isn’t Enough..................................................... 267


Table of Contents
Chapter 16: Seeing How Some Companies Lie, Cheat,
and Steal Their Way to the Top . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269
Did You Really Sell That? When Companies Aggressively
Report Revenue......................................................................................... 270
Don’t let the sun go down on me...................................................... 271
The truth?............................................................................................ 272
Lucy, You Got Some ’Splainin’ to Do: When Companies Understate
Their Expenses.......................................................................................... 274
What a waste....................................................................................... 274
Crazy like a fox.................................................................................... 275
Missed It by That Much: When Companies Overstate
Their Financial Position........................................................................... 276
Those pesky pensions: The epidemic of firms understating
pension liabilities............................................................................ 276
We are the world................................................................................. 280
Keeping Investors Off-Balance.................................................................... 281
Enron’s special purpose.................................................................... 282
A mountain of a scandal..................................................................... 284
Swap meet............................................................................................ 286
What Should an Investment Banker Do?................................................... 287

Chapter 17: Understanding Alternative Investments and
Asset Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289
Knowing Your Alternatives......................................................................... 289
Hedge funds......................................................................................... 290
Venture capital.................................................................................... 292
Commodities....................................................................................... 293
Real estate........................................................................................... 295
Digging Into Asset Management................................................................. 296
Attracting investors to asset management...................................... 296
Creating asset management tools..................................................... 297
Managing Potential Conflicts with Clients................................................. 299
How asset management can cause conflicts................................... 299
How to eliminate and manage conflicts........................................... 301

Chapter 18: Trying Your Hand at Investment Banking
with a Case Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303
Setting the Scene.......................................................................................... 303
The acquirer........................................................................................ 304
The target............................................................................................ 304
Considering the Options.............................................................................. 305
Identifying the options....................................................................... 305
Looking at financing........................................................................... 306
Creating the Analysis................................................................................... 307
An analysis of the financial statements........................................... 307

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Investment Banking For Dummies
Structuring a Deal......................................................................................... 310
Form of acquisition............................................................................. 311
Creating pro forma statements......................................................... 311
Success or Failure......................................................................................... 314

Part V: The Part of Tens............................................. 315
Chapter 19: Ten of the Biggest Debacles in Investment
Banking History. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 317
The Dot-Com Boom and Bust...................................................................... 318
Tainted Research Scandals......................................................................... 319
Enron and the Accounting Scams............................................................... 319
The Mortgage Debacle and Collapse of Lehman...................................... 320
The Flash Crash............................................................................................ 321
The London Whale at JPMorgan and Barings Bank................................. 321
Long-Term Capital Management................................................................. 322
Bankruptcy in Jefferson County, Alabama................................................ 323
IPO Allocations with CSFB........................................................................... 323
Bad Mergers and Acquisitions Like AOL Time Warner........................... 324

Chapter 20: Ten Ways to Improve a Discounted
Cash Flow Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 325
Financial Analysis Isn’t Physics.................................................................. 325
Show Your Sensitive Side............................................................................ 326
Monte Carlo Isn’t Just for High Rollers...................................................... 327
What Can Go Wrong Will Go Wrong........................................................... 327
It’s Tough to Make Predictions, Especially about the Future................. 328
The Investor of Today Doesn’t Profit from Yesterday’s Growth............ 329
Garbage In, Garbage Out.............................................................................. 330
Rates Are Falling — It’s a Better Deal!........................................................ 330
Read Your Putt from Several Angles.......................................................... 331
The Weighting Is the Hardest Part............................................................. 332

Chapter 21: Ten (Or So) of the Best Online Resources
for Investment Bankers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333
Bloomberg..................................................................................................... 333
Reuters........................................................................................................... 334
Standard & Poor’s......................................................................................... 335
Renaissance Capital and IPOScoop.com................................................... 335
The Securities and Exchange Commission............................................... 336
Moody’s......................................................................................................... 336


Table of Contents
FreeStockCharts.com................................................................................... 337
Index Fund Advisors.................................................................................... 337
Morningstar................................................................................................... 338
Bureau of Labor Statistics........................................................................... 338
Department of Commerce........................................................................... 339
Federal Reserve............................................................................................ 339
Trefis.............................................................................................................. 340

Appendix: Where Investment Banking Came From........ 341
Index........................................................................ 349

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Investment Banking For Dummies


Introduction

I

nvestment banking is the fuel of capitalism.

Human progress takes money and ideas. But more times than not, the people
with the money aren’t the same ones with the ideas. Having a mound of cash
and no creative ideas only creates a mound of money. Meanwhile, an entrepreneur with all kinds of dreams can’t even break ground if there’s no cash to
break ground with.
Enter investment banking. Investment banking has been mankind’s solution
to pairing up the people with money and the people with ideas. The combination of money, or capital, and entrepreneurship is a dynamic marriage that’s
behind some of mankind’s greatest accomplishments. Investment banking
has financed ’round-the-world trade expeditions and built railroads and
bridges.
Given the great role investment banking plays in the financial system, it has
taken on a larger-than-life mystique with the masses. Many people suspect
that investment banks are pulling the strings of the economy, but they may
not know enough to realize exactly what investment banks do.
Get ready to take a peek into the private and important world of investment banking. This book could just have easily been called Wall Street For
Dummies, because it’s your guide into the complex but pivotal world that
Wall Street plays in making the financial system work.
We wrote this book not only to help you understand what’s done on Wall
Street, but also to show you how to use some of the financial tools that help
measure financial performance. After reading this book, you’ll know how Wall
Street works, and how to put its secrets to work for you.

About This Book
Believe it or not, investment banking affects you.
You may not live in Manhattan, under the shadow of the giant skyscrapers
of Goldman Sachs and Morgan Stanley. You may not even be involved in the
financial industry — your only dealings with a bank may be when you stop to
take money out of the ATM.


2

Investment Banking For Dummies
But investment banking is so much a part of the financial system that,
whether you realize it or not, you fall into its shadow. The fact of the matter
is, if you’re like most people, managing your money is falling increasingly on
your shoulders. Gone are the days when you could work at a company for 40
years and expect to have a fat pension waiting for you in retirement.
Today, managing your money and making sure you have enough to pay for
life’s biggest investments — including homes, cars, college, and retirement —
is up to you. You can’t do it alone, though. Stuffing your money into a box and
burying it in the backyard definitely won’t cut it. If the termites don’t eat up
your life’s savings, inflation will. Each year, prices for goods and services rise,
eroding the power of your savings.
The only way to keep up with the ravages of inflation is to invest your money.
And that’s where Main Street usually becomes acquainted with Wall Street.
Main Street has money in search of returns, and Wall Street is busy cooking
up financial investments that it says will deliver those returns.
Typically, investment banking is a pretty heady topic that’s discussed in MBA
classes or in important-sounding books with long and intimidating titles. But
in Investment Banking For Dummies, we break down the topic into understandable pieces.
Keep in mind that this book, like all the books in the For Dummies series,
doesn’t have to be read cover-to-cover (although we’ll be flattered if you read
it all). Each of the topics is broken down into easy-to-digest parts and chapters. Feel free to skip around the book to areas that interest you most, and
save the parts that seem irrelevant until you’re curious about them later.
While reading this book, keep in mind that we’re trying to explain the topic,
not impress you with how complicated the topic is. To help signal when a
topic is about to get hairy, look for the Technical Stuff icon in the margin.
When you see that icon, it means the information is great if you sleep with a
calculator on your pillow instead of a teddy bear, but feel free to skip it if it’s
too much to handle right now.
The same goes for the gray boxes of text known as sidebars. In the sidebars,
you’ll find interesting but slightly tangential material that you can skip if you
want. We found the information interesting enough to put it in the book, but
it’s not essential to your understanding of the topic at hand.
Within this book, you may note that some web addresses break across two
lines of text. If you’re reading this book in print and want to visit one of these
web pages, simply key in the web address exactly as it’s noted in the text,


Introduction
pretending as though the line break doesn’t exist. If you’re reading this as an
e-book, you’ve got it easy — just click the web address to be taken directly to
the web page.
Finally, we’ve written this book so it contains everything you need to know.
If there’s an obscure financial term or ugly-looking formula, we include
the details and give instructions on how to use it. Although you’re free to
read other relevant financial titles in the For Dummies series, including
Fundamental Analysis For Dummies, by Matt Krantz (Wiley), it’s not necessary. If you’re more interested in investing for yourself, rather than the process of investment banking, check out Investing Online For Dummies, 2nd
Edition, also by Matt Krantz (Wiley). Okay, that’s enough of the shameless
self-promotion.

Foolish Assumptions
Because you have this book in your hands, we assume that you have a
greater-than-average amount of curiosity about the way our financial system
works. You probably read the financial press and know what the big financial
players are doing in general, but you don’t really understand how and why
they’re doing it.
We also assume you’re not an investment banker, because we haven’t met
many investment bankers who would admit to being a dummy. But you’re
probably somehow who wants to know was investment bankers do and
maybe even think about being one every time you watch Wall Street.

Icons Used in This Book
To draw your attention to certain kinds of information, we use a series of
icons. Here’s what the icons mean:


Investment bankers have no shortage of techniques that make their jobs
easier. You’ll find those marked with the Tip icon.



This book is a reference, which means you can turn to it again and again, to
look up the information you need. However, occasionally, we tell you something that’s so important, you’ll want to commit it to memory, and when we
do, we use the Remember icon.

3


4

Investment Banking For Dummies


Danger! Danger! Investment banking is full of perils and possible screw-ups.
We flag you to these pitfalls so you can avoid taking down a 100-year-old
investment banking firm with a multi-billion-dollar blunder.


Investment banking can be complicated stuff. And it’s a shame that the complexity of investment banking can be a turnoff for some. When we talk about
subjects that are especially gnarly, we mark the info with a Technical Stuff
icon, so you can breeze on by.

Beyond the Book
In addition to the material in the print or e-book you’re reading right now, this
product also comes with some access-anywhere goodies on the web. If you’re
craving even more information on investment banking, check out the free
Cheat Sheet at www.dummies.com/cheatsheet/investmentbanking.
There, you’ll find more on what investment bankers do, why companies buy
other companies, and how to get in on an initial public offering, or IPO.
In addition, we’ve written several articles on topics ranging from how to read
analyst reports to understanding cash flow. They’re available at
www.dummies.com/extras/investmentbanking.

Where to Go from Here
So, what are you waiting for? The world of investment banking is fascinating,
and waiting for you to dive in. When you understand how Wall Street works,
you’ll know how to make investment banking work for you, instead of getting
worked over by the world’s biggest banks. Flip through the book, and start
reading anywhere you see something interesting!


Part I

Getting Started with
Investment Banking



For Dummies can help you get started with lots of subjects. Visit www.dummies.com
to learn more and do more with For Dummies.


In this part . . .


✓ Discover the role investment banking plays in the financial
system so you can understand the types of services that are
provided in the economy.



✓ See how investment bankers interact with investors in order to
appreciate the primary job of moving money from those with
extra cash to those who need it.



✓ Look at the process of selling a company to investors so you
can see the purpose of one of the key functions served in
investment banking.



✓ Recognize what goes on in merger activity so you can see how
deals are done and what your job may be as an investment
banking professional.


Chapter 1

Introducing Investment Banking
In This Chapter
▶Understanding what investment banking is
▶Recognizing the critical role investment banking plays in the capital formation process
▶Discovering how investment banking compares with traditional banking
▶Finding out how investment banking operations make their money
▶Looking at the different types of investment banks and what they do

I

f you’re like most people, when you hear the term investment bank, one of
a few things may cross your mind. Your eyes may glaze over as you think
about mind-numbingly detailed financial statements and valuation metrics.
Yawn. Or, you may think of exciting high-stakes financial maneuvers, like
those out of the movie Wall Street, where well-dressed bankers treat companies like Monopoly squares to be dispassionately bought and sold.
But maybe you’re attracted to investment banking by the mental gymnastics
required and the promise of big bonuses and riches to those who are in the
know. And that may be why you picked up this book.
As you can see, there are many preconceived notions about investment banking and investment bankers. Many of these ideas, though, are often pieces of
fiction blended with stories of larger-than-life personalities of high finance
that spill out of the pages of the money section of financial publications.
In this book, we tell you what really happens in the investment banking
world. This chapter introduces you to the high-level reality of what investment banking is. Here, you see how Wall Street really works. In this chapter,
you see that although investment banking can be extremely lucrative, it’s also
an important facilitator of economic growth and traces its roots to the idea of
putting money into the hands of the dreamers and creators.


8

Part I: Getting Started with Investment Banking

What Investment Banking Is
If you’re like most people, you probably figure investment banking got its
start in a towering office skyscraper in New York City. But the real story of
the origin of investment banking is far less metropolitan, yet arguably even
more interesting. Investment banking traces its roots to the age of kings and
queens. Many of the most commonly used financial instruments trace their
origins to centuries ago when bankers navigated the edicts of rulers and,
believe it or not, religious leaders. If you’re interested in the very early days
of investment banking, check out the appendix for a quick history lesson.
But for now, just know that investment banking is, at its very core, pretty
straightforward. Investment banking is a method of controlling the flow of
money. The goal of investment banking is channeling cash from investors
looking for returns into the hands of entrepreneurs and business builders
who are long on ideas, but short on bucks.


Investment bankers raise money from investors, by selling securities, and
then transfer that money to people who need cash to start businesses, build
­buildings, run cities, or bring other costly projects to reality.
There are many aspects of investment banking that muddy this fundamental
purpose. But in the end, investment bankers simply find opportunities to
unlock the value of companies or ideas, create businesses, or route money
from being idle to having a productive purpose. (In Chapter 2, you discover
the purpose of investment banking.)

The role investment banking plays
Investment bankers get involved in the very early stages of funding a new
project or endeavor. Investment bankers are typically contacted by people,
companies, or governments who need cash to start businesses, expand factories, and build schools or bridges. Representatives from the investment banking operation then find investors or organizations like pension plans, mutual
funds, and private investors who have more cash than they know what to
do with (a nice problem to have) and who want a return for the use of their
funds. Investment banks also offer advice regarding what investment securities should be bought or the ones an investor may want to buy.


One of the trickiest parts of understanding investment banking is that it’s typically a menu of financial services. Some investment banking operations may
offer some services, but not others.


Chapter 1: Introducing Investment Banking
The services offered by investment banks typically fall into one of a few
buckets. One of the best ways to understand investment banks is to examine all the functions that some of the biggest investment banks perform. For
example, Morgan Stanley, one of the world’s largest investment banks, has its
hands in several key business areas, including the following:


✓Capital raising: This part of the investment banking function helps companies and organizations generate money from investors. This is typically done by selling shares of stock or debt.



✓Financial advisory: In this role, the investment banking operation is
hired to help a company or government make decisions on managing
their financial resources. Advice may pertain to whether to buy another
company or sell off part of the business. A common business decision
tackled by this type of investment banking is whether to acquire another
company or divest of a current product line. This is called mergers and
acquisitions (M&A) advisory.



✓Corporate lending: Investment banks typically help companies and
other large borrowers sell securities to raise money. But large investment banks are also frequently involved in extending loans to their customers, often short-term loans (called bridge loans) to tide a company
over while another transaction is in the works.



✓Sales and trading: Investment bankers are a creative and innovative lot,
in the business of constructing financial instruments to be bought and
sold. It’s natural for investment bankers to also buy and sell stocks and
other financial instruments either on the behalf of their clients or using
their own money.



✓Brokerage services: Some investment banking operations include brokerage services where they may hold clients’ assets or help them conduct trades.



✓Research: Investment banks not only help large institutions sell securities to investors, but also assist investors looking to buy securities.
Many investment banks run research units that advise investors on
whether they should buy a particular investment.

The terms investments and securities are pretty much interchangeable.


✓Investments: Investment banks typically serve the role of a middleman,
sitting between the entities that need money and those that have it. But
periodically, units of investment banking operations may invest their
own money in promising companies or projects. This type of investment, often made in companies that don’t have investments that the
public can buy, is called private equity.

9


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