Capital Markets and Investment Banking Process - Essay Example

Capital Markets and Investment Banking Process Investment Banking Process: Investment banking has no features like the traditional banking. Investment banks are involved in public and private market transactions for investors, companies and governments. Investment banks advise and assist its clients in issuing of debt and equity securities, mergers, acquisitions, diversification etc. Investment banker’s services are acquired when a company needs to raise funds in the financial markets usually through the issuance of new securities. Investment banks usually perform three tasks: first, they assist the companies in designing the securities which have features that are most appropriate for a certain market; second, they buy these securities and third, they resell them to the investors. (Fabozzi, 2008) Investment banks raise capital for their client companies through underwriting in which it purchases a whole block of new securities and resells them to investors. In this way, the income earned is the difference of the amount given to purchase the new block of shares and the amount received by the investors. Apart from Merger & Acquisition (M&A) advisory services, a bank’s another integral and core function nowadays is Investment Management in which the bank manages the investments of clients. Security services are also an important feature for investment banks which include prime brokerage, financing and securities lending. Regardless of the activity undertaken by the investment bank, it needs to focus on its portfolio construction and management which will be done according to the portfolio strategy of the investment bank. This means the bank needs to make investments which ensure successful trading that could be done by making risk management a top priority. This would mean that if a company incurs a loss of on one of its investment, it should earn a profit of over 11% on another to make it even. In this way, the company needs to construct a portfolio of investments which ensures a favorable position for the company. (Fabozzi, 2008) Factors to Be Considered Selecting Asset Classes For An Investment Portfolio: Asset class means the different kinds of assets (e.g. bonds, equities and cash equivalents etc.), while making an investment portfolio, different classes of assets are added according to investment policies and objectives. For making an investment portfolio, it is generally considered that a well diversified portfolio is beneficial as it outweighs the losses through other profitable investments. On deciding upon the asset classes, the companies need to consider asset allocation among different classes of assets. Studies show that 85 to 95% of investment’s returns are due to asset allocation policy and not selection of specific stocks or bonds. While selecting classes of assets, major considerations should be given to the capital market expectations as to which classes of assets are expected to outperform others in short, medium or long term. For example, if the stock market is expected to be weak, there should be more bonds in the portfolio. Other factors that need to be considered while deciding upon the asset allocation are the objectives of investment which would consider the timings, the need of the investment and the expected return of the investment by the client. Risk tolerance and risk policies need to be given special consideration in deciding upon the allocation of assets that should be in accordance to the bank and clients. Constraints associated with asset classes like liquidity, taxes, regulations etc and capital market assumptions are also few factors that should be considered. (Chandra, 2009) Describe the Capital Market Instruments Used in Investment Portfolio Construction: The capital market is vital for a country as it matches the players who have excess funds with the ones who are in need of funds. The instruments are traded in these markets incurring a gain/loss on these securities. Capital market instruments can be widely categorized as debt and equity markets which are traded in their respective markets and are used in the portfolio construction. Debt Instruments: Debt instruments have a fixed income claim and have a maturity of over a year. These include debentures and bonds traded in the debt markets. Debt instruments are available with several features which include secured or unsecured that define the risks associated with the debt. Redeemable or irredeemable, it defines the flexibility in the maturity periods and based on the interest on payments the debts are classified as regular interest, flexi interest and zero coupon. Equity Instruments: Equity instruments give rights of ownership in the issuing entity or corporation to the public and are traded in equity markets. The owner of these equity instruments will have a share in the profit in the form of dividends and not a fixed interest payment. The equity instruments are also of many types like preference equity and common equity. Preference shareholders have preferred rights over the company at the time of dividend payments and liquidation while the common equity holders are secondary in preference. The debt and equity markets are subdivided into primary and secondary markets. The primary markets deal in new and fresh securities usually for a new company while the secondary market trades in already issued securities. (Ranganatham & Madhumathi, 2005) General Recommendations for the Composition of an Investment Portfolio: Investment portfolio should be constructed in accordance to the investment objective (timings, return, and needs) and the risk appetite of the investor. Hence, there is no specific formula for the most appropriate investment portfolio. However, a few guidelines that should be considered are: The investments should include more of income generating investments rather than capital gain generating investments as they are riskier in nature. There should be a larger portion of investment made in money market instruments and debts as they are safer than equity instruments if the market gets unpredictable. There should always be a balance between high risk investments and low risk investments. For example, if there is an estimated loss of 5% in a high risk investment, there should be a supporting low risk investment that will generate a fixed 10% gain. References Chandra, P. (2009). Investment analysis and portfolio management. New York: McGraw-Hill Professional. Fabozzi, F. J. (2008). Handbook of Finance: Financial Markets and Instruments. Hoboken: John Wiley & Sons. Ranganatham, M., & Madhumathi, R. (2005). Investment analysis and portfolio management. Delhi, India: Pearson Education (Singapore. Read More