BANK3014 INVESTMENT AND PRIVATE BANKING
WEEK 2 TUTORIAL
Concept Review Questions
1. Briefly explain the possible linkages amongst the various segments of the financial services industry. Have these linkages changed over time? If so, how have they changed? Give appropriate examples.
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2. What are the key factors behind the current and emerging trends in the linkages between the commercial and the investment banking segments of the financial services industry?
3. Explain the extent to which changing regulatory environments and market factors have led to both the rise and the decline of the “Pure Play” investment banks, both internationally and in Australia.
4. What are the differences and similarities between the way in which commercial banks and investment banks undertake financial intermediation. To what extent do you consider that these factors have contributed to the trends that you have noted in Question 2 above?
5. Briefly describe the key operating divisions or activity segments of investment banks. How do each of these contribute to the financial intermediation role undertaken by investment banks?
Extension Question; an Open Question
1. Having regard to the developments that you identified above, what future changes in the structure and operations of investment banks do you consider are likely to occur? Give reasons.
2. Read article “ of universal bank.
” on Canvas and discuss the advantage and disadvantages
The Muscle Flexed in the $74 Billion
Bristol-Myers Deal
BANK3014 INVESTMENT AND PRIVATE BANKING
WEEK 3 TUTORIAL QUESTIONS BASED ON WEEK 2
(Note: Some questions adopted from CFA)
Concept Review Questions
1. Identify the key factors that an issuer of equity will consider in selecting an investment bank to be the lead manager of its equity issue. What attributes must an investment bank be able to demonstrate to indicate its credentials in relation to these key factors and what types of metrics do you consider would be useful to do this?
2. What are the key functions that the lead manager in an initial public offering performs. What are the risks associated with these functions and how can the investment bank who acts as the lead manager mitigate these risks?
3. To what extent do you think that underwriting is an important activity undertaken by investment banks in the issuance of new equity? What are the two principal types of underwriting arrangements? How can an investment bank manage the risks that it is exposed to in each of these two types of underwriting arrangement?
4. What would motivate a Company consider the issuance of a secondary equity issue? What role does and investment play in secondary market issues and in particular what factors do you consider an investment bank should consider in arriving at a recommendation to its client on the most appropriate instrument/s to be issued?
Extension Questions
1. Providetworeasonswhythestockpricemayfallontheannouncement of a follow-on equity issuance?
2. Dilution Inc. has one million shares on issue currently worth $5 each. The company as a whole is therefore worth $5 million. It needs $1 million to invest in a new project. It raises the cash through a rights issue. It offers existing shareholders one new share for every four shares already owned, at a specially discounted price of $4 per new share. In effect, the shareholders are given options to buy new shares at a 20% discount. Suppose a shareholder in Dilution Inc. decides to sell on his or her rights ‘nil paid’ to someone else. ‘Nil paid’ means that whoever acquires the rights will later have to pay $4 per share to Dilution Inc. to exercise the rights and purchase shares.
a. What is a fair price to charge for the rights?
b. Suppose there exists a shareholder who, before the rights issue
is announced, owns a portfolio consisting of 100 Dilution Inc. shares worth $ 500 plus $ 100 in cash, a total value of $ 600. Describe this shareholder’s financial position if she takes up the rights or sells them at the fair price?
3. Playtech is a designer, developer, and licensor of software for the gambling industry. On 28 March 2006, Playtech raised approximately $250 million gross through an initial public offering of 100,000,000 ordinary shares at $2.50 per ordinary share. After the initial public offering, Playtech had 225,000,000 ordinary shares issued and outstanding.
Playtech received gross proceeds of approximately $40 million and net proceeds of $31.8 million. The ordinary shares that were sold to the public represented approximately 48% of Playtech’s total issued ordinary shares.
The shares commenced trading at 8:00AM on the AIM market of the London Stock Exchange, where Playtech opened at $2.64, traded 37 million shares between $2.58 and $2.64 and closed at $2.63.
a. Approximately how many shares were issued by the company and how many shares were sold by the company’s founders? What fraction of their holdings in the company did the founders sell?
b. Approximately what return did the subscribers who participated in the IPO make on the first day it traded?
c. Approximately how much did Playtech pay in placement costs as a percentage of the new funds raised?
BANK3014 INVESTMENT AND PRIVATE BANKING
WEEK 4 TUTORIAL QUESTIONS BASED ON WEEK 3 (Note: Some questions adopted from CFA)
Concept Review Questions
Consider the following assets and contracts:
Bank deposits
Certificates of deposit Common stock
Corporate bonds Currencies Exchange-traded funds Lumber forward contracts Crude oil futures contracts Gold
Hedge funds
Master limited partnership interests Mortgages
Mutual funds
Stock option contracts
Preferred stocks
Real estate parcels
Interest rate swaps
Treasury notes
a. Which of these represent ownership in corporations
b. Which of these are debt instruments?
c. Which of these are pooled investment vehicles?
d. Which of these are real assets?
e. Which of these would a home builder most likely use to hedge construction costs?
f. Which of these would a corporation trade when moving cash balances among various countries?
Describe four advantages to the issuing company (ABC Co.) of using convertible loan notes a source of long term finance.
Describe the difference between an indenture, a covenant and a debenture.
4. Provide the missing information in the table below relating to debt issuances.
Collateral
Interest Rate
Amortization
Prepayment
Super Senior
Debt / First
Super Secured Debt
Secured Debt
Term Loan B, Bonds
Term Loan C, Bonds
Subordinated Debt
Term Loan D, Bonds
Hybrid Securities
Debt, Convertible Bonds
5. The following chart contains data sourced from Bloomberg. It shows the credit spreads for BBB rated borrower, which is equivalent to the lower range of investment grade borrowers. The data shows the changes in credit spreads for fixed rate borrowings of various terms to maturity in the US and Australia. Consider the data and provide comments around:
a. Why do credit spreads change over time?
b. Why are credit spreads for the same class of borrowers different for different maturities?
c. If you were advising a borrower on the new issue of debt what factors should the borrower consider when choosing the structure of debt finance to issue and what factors might be considered by the potential investors in the issue in deciding how much to invest and on what terms?
Jun-15 Dec-15
AUD BBB Credit Spreads
Jun-15 Dec-15
USD BBB Credit Spreads
6. Describe the difference between an underwritten debt offering and a best effort offering from the perspective of an investment bank.
7. Describe why a call provision is beneficial to the issue while a put provision and a conversion provision are not.
Extension Question
1. A client of your investment bank has a bill facility with a remaining term of 3 years which allows them to drawdown and rollover bills of exchange with a term of 90 days that are accepted by a major Australian bank. The facility has been priced at 90-day BBSW plus a margin of 1.5%pa. The client has approached you to fix its cost of funds for the remining term of the facility commencing today. You assess the market and identify that the market price to pay fixed in a 3-year Interest Rate Swap (IRS) for BBSW is 2.25%pa and you will add a spread of 0.25%pa to the quote to cover your credit risk and other costs.
a. You are required to advise the client what their cost of funds will be if they enter into the IRS and to provide the client with your reasons why the client should enter into the IRS. As part of your consideration of the transaction you have assessed that if the client were to issue a 3-year fixed corporate bond that the cost of funds is likely to be 5%pa.
b. You have identified an opportunity to offset the transaction at the market rate with a government financing authority. The authority is considering issuing a 3-year state government guaranteed bond at a yield of 3%pa with quarterly coupons. You are required to provide advice to the government client around the benefits of entering into the IRS.
c. Extension Question for part (a). Whilst not covered in the lecture, consider what the client’s settlement positions would be for:
i. The first rollover of the IRS which starts today (i.e. the interest amounts due on the BAB borrowing and the fixed and floating legs of the IRS payable and receivable in 3 months if today’s 90-day BBSW rate (which is the floating rate on the IRS) is 2.0%pa.
ii. The second rollover of the IRS which starts in 3 months’ time (i.e. the interest amounts due on the BAB borrowing and the fixed and floating legs of the IRS payable and receivable in 6 months if the 90-day BBSW rate (which is the floating rate on the IRS) is 2.25%pa in 3 months’ time.
BANK3014 INVESTMENT AND PRIVATE BANKING
WEEK 5 TUTORIAL BASED ON WEEK 4 MATERIAL
Concept Review Questions
1. What functions do the Trading and Sales operations of investment banks perform? Why is it important that investment banks perform these services?
2. Howdotradersoperateinboththeprimaryandsecondarymarkets?
3. What are the two main counterparties that prime brokers act as an intermediary between for hedge funds? What risk does the prime broker bear in the course of providing this service?
4. Describetheoperationofthefollowing:
(a) Securities lending
(b) Margin lending
Your answer should consider:
(i) the counterparties that investment banks provide these
services to;
(ii) how they work;
(iii) the benefits that are delivered to the counterparties and the investment bank;
(iv) how they are priced; and
(v) the functions performed by investment banks.
5. Explain the operation of the two principal types of market making services provided by investment banks. How does the investment bank’s risk profile different in each of these activities? How can a market maker bank manage the risks that arise from these activities?
6. Algorithmictrading
(a) Explain the difference between Algo Trading and Algo Execution
Trading models.
(b) Briefly explain the operation of the two most common types of
Algo Execution Trading models.
(c) How have these changed the face of the trading function in
investment banks?
Extension Question
1. Recalling our example from the lecture of Fahmi Q looking to get short 100,000 shares of Valeant, our market maker quoting Valeant at $260/$262 with a 10bps commission, and looking to get long 100,000 shares of Valeant.
(a) As an agency trade assume a trader receives Bill’s order and fills it at the current mid-price (which we will assume is VWAP). What’s the P&L if the order is crossed at a venue?
(b) What’s the P&L if the trader crosses Bill and Fahmi at the mid?
(c) If the trader chooses to go on risk to Bill, and fills his order at the initial quoted ask-price, what is the directional position of the
market maker?
(d) If the trader closes the position at a venue at a price of $262.10
what is their total P&L?
(e) If we assume this trade is a good representation of this trader’s
median performance what is their retention ratio? What does the retention ratio measure?
2. Read the articles related to Archegos’s fall in 2021 on Canvas and discuss the risks management issues faced by IBs when they provide prime brokerage services.
BANK3014 INVESTMENT AND PRIVATE BANKING
WEEK 6 TUTORIAL QUESTIONS BASED ON WEEK 5 MATERIAL
Concept Review Questions
1. What distinguishes proprietary trading from market making?
2. Outline and describe technical and fundamental analysis. Critically assess the differences between the two and their uses in trading.
3. How can a market maker in fixed income markets manage the risk of the negative selection portfolio they are assigned by fulfilling client flow?
Extension Questions
Suppose that the risk-free interest rate is 10% per annum continuously compounded, the dividend yield on a stock index is 4% per annum. E- mini S&P 500 futures with 4-month expiry are at 405 and the index is currently trading at 400.
– Recall the theoretical futures price is 𝐹𝐹0 = 𝑆𝑆0𝑒𝑒(𝑟𝑟−𝑞𝑞)𝑇𝑇 Where: F0 is the theoretical futures price
S0 is the current price of the underlying stock index r is the risk-free rate of return
q is the dividend yield on the underlying stock index T is the time to expiry of the futures
e is exponential
(a) What is the theoretical futures price?
(b) What arbitrage opportunities (this will involve either buying the
futures and then selling the index or vice versa) if any does this market environment create?
The table below sets out the yield curve for government bonds. Assume all bonds pay annual coupons and are currently at PAR.
Recall the formula to calculate a bond’s price is:
(1−(1+𝑖𝑖)−𝑁𝑁 𝐹𝐹𝐹𝐹
𝑃𝑃 = 𝑐𝑐 ∗ 𝐹𝐹𝐹𝐹 � 𝑖𝑖 � + �(1 + 𝑖𝑖)𝑁𝑁�
Where: P is the bond’s price c is the coupon rate
FV is the bond’s face value
i is the market yield
N is the number of compounding periods
(a) Whatisthetotalreturnachievedbybuyinga10Ybondandselling it after one year, given the following yield curve and assuming it remains unchanged over the one year period?
(b) What is the yield that could be earnt over the one year period by investing in the one year bond and holding it to maturity?
(c) Compare the return from the two strategies. What are the risks associated with the strategy in (a) compared to that in (b)?
Maturity Yield
3. Your economics team hands down an analysis which suggests that the economy is likely to perform better than expected. You’re asked to recommend a strategy to capitalise on this analysis.
(a) What would you expect to be the change in credit spreads between high yield corporate bonds and government bonds if the analysis is correct? Give reasons for your view.
(b) Using the two bond exchange traded funds (ETF’s) HYB (which comprises high yield corporate bonds) and GBS (which contains government bonds), how would you structure a spread trade that expresses this view?
(c) If you only have the ability to manage your corporate bond inventory vs your government bond inventory (i.e. either increase the holdings of one (being overweight) vs the other (being underweight)), which one(s) would you choose to be under/overweight?
BANK3014 INVESTMENT AND PRIVATE BANKING
WEEK 7 TUTORIAL QUESTIONS BASED ON WEEK 6 MATERIAL
Concept Review Questions
1. WhataretherisksinherentinFXdealing?
2. Whatarethe4mainrisksfacedmorebroadlyinFX?
3. What are the main factors that drive movements in foreign exchange rates? Explain how changes in these drivers are likely to influence the exchange rate.
4. Explain how an FX Swap can be used to create synthetic borrowings and loans across currencies? Explain how this process would be useful for the clients of investment banks.
5. What other uses, apart from that considered in Q4, does an FX Swap have for clients with exposure to the FX market? Explain how the swap could be used in these circumstances.
Extension Questions
1. GiventhefollowingtradeblotterforaGBPUS
USD bought (+) sold (-)
GBP bought (+) sold (-)
Net GBP position
-17,523,000
+10,000,000
+10,000,000
– 8,762,500
+ 5,000,000
+15,000,000
+17,527,000
-10,000,000
+ 5,000,000
+17,524,000
-10,000,000
– 5,000,000
a. What’s the trader’s position after the fourth trade in the blotter above?
b. What is the size and direction of GBP/USD the trader would have to take to close out the overall position?
c. Describe how the trader could shade their rates to close their overall position assuming the final deal rate is the mid with a 4 pip spread?
d. Marking the trader’s position to market at the revaluation (reval) rate end of day of 1.7490, what is the PNL in GBP and USD terms?
e. WhatisthenetopenP&L?
2. Recalling our FX and money market rates, as on May 1, and the bank of Corzine & Paulsen needing to pay £10m in 3 months for an acquisition.
0.5120 – 0.5152
1m forward
0.5141 – 0.5171
3m forward
0.5171 – 0.5202
5.00 – 5.50
2.00 – 2.40
a. You have decided to recommend to the client that they hedge the payment risk using a forward FX contract. What rate could the client obtain to hedge this risk?
b. What are the amounts that the client will be required to pay and receive at the time of the settlement of the forward FX transaction?
c. What factors, including market considerations, would you recommend the client consider in deciding whether or not to enter into the Forward FX hedge?
d. Couldthisriskbemanagedbytheclientinanyotherway?
3. is a medium-sized Australian company whose ordinary shares are all owned by the members of one family. It has recently begun exporting to a European country and expects to receive €750,000 in six months’ time. The prospect of increased exports to the European country means that would need to expand its existing business operations in order to be able to meet future orders.
All of the family members are in favour of the planned expansion, but none are in a position to provide additional finance. The company is therefore seeking to raise external finance of approximately AUD1 million by drawing down a line of credit that it has available to it. The family members are of the view that the European business will require this initial funding for 1 year only, after which time it will be self-funding and the investment will be able to be fully repaid.
At the same time, the company plans to take action to hedge the exchange rate risk arising from its current European exports.
The current market interest rates in Australia (AUD) and Europe (EUR) to borrow and lend respectively are set out in the table below. The current spot exchange rate is 1.600 euro per 1AUD.
b. Explain the options to finance the proposed European operation over the one-year timeframe. Show how you would calculate the FX rates for the transaction/s that would be required to facilitate this financing. What would you recommend and why?
AUD Interest Rates %pa
EUR Interest Rates %pa
What is the forward exchange rate that Martin could obtain a
quote to hedge its EUR export income in six months?
BANK3014 INVESTMENT AND PRIVATE BANKING
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