-

Classification of Investment Banks:

o Equity capital markets ECM
o Debt Capital Markets DCM
o Currency & Commodities FICC(Fixed Income Currency &
Commodities)
o Valuation Advisory
o Tax Advisory
o M&A and Restructuring Advisory
o Credit rating Advisory
o Private Equity, Venture Capital & Hedge Funds
o Sales, Trading, Brokerage, Risk Management
o SWF Sovereign Wealth Fund
o PMS Portfolio Management Services
Income
o Fee Based
o Fund Based (Risk)
Type of IBs
o Bulge Bracket big full
o Boutique IBs ( Most of Indian Banks are these as they do not
provide all the above services)

Note on IPO Process

o
o

o
o
o

Case
o
o
o
o
o
o

Why do firms exist?

Sir Ronald Coase Industry Organization - Transactional Cost
Economics
Facilitates exchange profit
Need for exchange of products or services
Problems with Capital Market
Information Asymmetry
Adverse Selection / Moral Hazard
Function of Intermediaries is to Reduce transaction cost
improve efficiency
IBs Add to volatility of the market
IBs bring in efficiency of the market
Absence of arbitrage leads to efficient markets
Fresh Water Economics & Salt Water Economics
Fresh Water Economics says leave it to the market forces
To Raise Capital
The Firm requires capital for its expansion
Bank Based to Market Based
Go to Market Unlock the Value
Firms which are listed
Price Discovery Daily Market Price
Firms which are yet to be listed
Locked Value Unlock the value
IPO
Sell the stake to another investor
Easy entry and exit

Manipal Leisure & Business travels Limited (MLBLT)

Authorized share capital of 100Mn shares of Rs 10 each
Issue, Subscribed, Paid Up 60Mn shares of 10/Each
Additional Capital Requirement : 200 MN
Value Per Share 50
No. of shares to be issued : 200/50 = 4 Mn
How many shares to be offered
Valuation
Current Market Price

o
o
o
o

Done by a IB
Third Party
Incorporation : MOA, AOA; Capital clause : Authorized Share Capital
Post Issue Paid up capital = 500 Mn =100
The new issue: 10 Mn =10/500 = 2%
The Present issue constitutes 2% on a fully diluted basis
Pre-Money and Post Money = Investment made by the PE

Session 3
Offer for Sale
Fresh issue
Promoters: 93% share capital; public holding: 0%
Closely held company
Offered fresh issue: to raise capital for the firm: equity route
How many shares to be offered
The amount required for the company: general purpose; specific purpose
Factors that would impact the shares to be offered:

Amount required
Value per share

Issue less number of shares: better valuation

Valuation representatives:
a)
b)
c)
d)

52 week trading range

The PV of forecast from dalal street analysts
Sum of the parts (SOTP)
DCF

468 crores: 390 to 430

Issuer would like to charge a higher premium
Pre-SEBI era: CCI Controller of Capital Issues: Regressive
Fixed Price Mechanism How much premium to be charged Formula given by
CCI used for calculating the price
Post 1992: SEBI; BOOK BUILDING and Free pricing mechanism
Issuer, GCBRLM (Global coordinators & book building lead managers), institutions
decide the price
Investment appetite decides the price band auction
Auction:

English auction
Dutch Auction
French Auction

Post SEBI: Price dependent on demand and supply

HIGHER VALUATION: Discover the value
If there is higher valuation: issuer will offer less number of shares to reduce
dilution
Exiting investors: VC/ Promoters group purpose is to unlock the value
All public sector are owned by government and the signatory for the same is the
President.
Road Shows; Planned meeting marketing the offer
The valuation should go up when the company is moving from closely held to
widely held
Merits of going for an IPO; why do firms go for an IPO?
Exit Options:

The company goes public: fresh issue + offer for sale MHRIL
The VC/PE can sell the stake to a strategic or financial investor: Strategic
investors often pay a premium ( ex snapdeal wanting to buy flipkart or
tata buying jaguar to move into new market), but sometimes the company
might not agree to going for this route
The promoter can buy back

IPO primary equity offering first time

FPO secondary equity offering
Corporate Actions: Public Issue, Rights issue, convertibles, bonus, ESOPs, M&As,
CAPEX Against issue of equity, buy back (large cash holdings); Acquisitions

SESSION 4
The share capital is altered: increases, decreases
1.
2.
3.
4.
5.
6.
7.
8.
9.

IPO Additional Cash, change in no. of shares, change in net worth

FPO same as above
RIGHTS - same as above
BONUS No additional cash, increase in no. of shares, no change in net
worth (Adjustment between paid up capital and reserves, capitalizing the
reserves)
SPLIT (RATIO ADJUSTMENT) no additional cash, increase in no of shares,
no change in net worth
ESOP (add cash, change in no of shares, increase in net worth)
CONVERSION OF PREFERENCE DEBT INTO EQUITY (no cash, reduction in
debt, increase in shares, increase in net worth)
CAPITAL EXPENDITURE- (no change in cash, increase in equity shares,
increase in net worth, increase in FA)
BUY BACK (decrease)

If you bought 100 shares at the time of the first public issue of Infosys in 1993,
did not buy any additional shares or sell shares, what will be the number of
shares today?
Wealth maximization.
93- 100 shares
94 200 shares
97 400 shares
99 1600 shares
04 6400 shares
06 12800 shares
14 25600 shares
15 51200 shares

Session 5
1. IPO related calculations
2. Rights Issue theoretical value of a right, options to the
shareholder what is the impact on the wealth
a. Accept the rights and buy the rights shares
b. Sell the rights
c. Reject the rights
3. CCD Prospectus
4. INDIGO Prospectus
5. INFIBEAM IPO (First ecommerce co. to announce IPO)
6. Motilal Oswal IPO, Note on IPO Quiz in the next visit
7. PE & VC Investment related calculations
8. Introduction to M&As
BOLD Syllabus

PE & VC Investments
The firm requires funding
Firm is expecting an amount of investment from the PE
PE will take an equity stake

How much stake to be offered?

If the valuation is high for the firm, the stake to be offered to be is low
If required rate of return from the PE is high (IRR), the amount of investment will
be less for a given stake
1. Motilal Oswal
2. Flipkart
3. Term Sheets (Prospectus in PE business)

M & A:
Acquiring Firm Buying Firm
Target Firm Selling Firm

Acquiring Firm Buying Firm Build vs Buy Green field vs Brown field; Organic
vs Inorganic
Target Firm Selling Firm Sell vs Continue

Buying Firm:
Cost of building vs Cost of buying
Replacement Cost
Market Value of the firm
Market Value of the firm < Replacement Cost: Buy
When does a firm become a takeover target: MV/RC < 1 TOBINS Q < 1:
TAKEOVER TARGET

Expected Synergies: Revenue, cost, overall business Operating synergies Economies of Scale (EOS1) & Economies of Scope (EOS2)
ECONOMIES OF SCALE: Larger the volume of operation, less than average cost
per unit

ECONOMIES OF SCOPE: Using same common infrastructure, sell multiple

products & services
FINANCIAL SYNERGIES Larger Balance Sheet, More borrowing capacity, higher
collateral, less cost of debt
Acquiring Firm purchase
Target firm sale
How much the acquiring firm has to offer to the target firm & in what form?
Conduct valuation for the target firm
Different Models of Valuation: Listed Firm or Unlisted

Valuation of both acquiring & target is required

Valuation of the two entities required in a stock based acquisition

Session 6
Two firms: Acquiring Firm & Target Firm
Acquiring Firm: Freeport McMoran Metals & Minings
Target Firm: Phelps Dodget Metals & Mining

How the acquiring company offers Target Company?

1. Entirely stock based acquisitions
2. Entirely cash based (TATA)
3. Combination of cash & stock (FCX)
1 share of Target Company x shares of the acquiring company
1 share of target company = x rs.
1 share of target company = x rs + x shares of acquiring company
No of shares outstanding for acquiring and Target Company at the time of
acquisition
Value per share at the time of acquisition
Market capitalization of the two firms
No. of shares outstanding for Acquiring & target company at the time of
acquisition
Value per share at the time of the acquisition
Market capitalisation of the firm
Read:

FCX will acquire all of the outstanding common shares of Phelps Dodge for a
combination of cash and common shares of FCX for a total consideration of
$126.46 per Phelps Dodge share, based on the closing price of FCX stock on
November 17, 2006. Each Phelps Dodge shareholder would receive $88.00 per
share in cash plus 0.67 common shares of FCX. This represents a premium of 33
percent to Phelps Dodges closing price on November 17, 2006, and 29 percent
to its one-month average price at that date. The cash portion of $18 billion
represents approximately 70 percent of the total consideration. In addition, FCX
would deliver a total of 137 million shares to Phelps Dodge shareholders,
resulting in Phelps Dodge shareholders owning approximately 38 percent of the
combined company on a fully diluted basis. The boards of directors of FCX and
Phelps Dodge have each unanimously approved the terms of the agreement and
have recommended that their shareholders approve the transaction. The
transaction is subject to the approval of the shareholders of FCX and Phelps
Dodge, receipt of regulatory approvals and customary closing conditions. The
transaction is expected to close at the end of the first quarter of 2007. FCX has
received financing commitments from JPMorgan and Merrill Lynch to fund the
cash required to complete the transaction. After giving effect to the transaction,
estimated pro forma total debt at December 31, 2006, would be approximately
$17.6 billion, or approximately $15 billion net of cash.
Total offering made to PD (target firm) = 25.9 billion cash & stock
No. of shares of PD x offering per share = 26000 mn
Offering made per share = 126.46 = cash + stock = 88 + 0.67 stock of FCX
Offering made per share = 88 cash + 38.46 stock
38.46 = 0.67 shares of FCX
Value per share of FCX = 38.46/0.67 = 57.4 USD/share
No. of shares outstanding post acquisition = pre acquisition no. of shares +
shares offerd to the target company
% ownership offered (fully diluted) = 37%
Number of shares offered for 37% ownership = 137 million
Total no. of shares post acquisition = 137/0.37 = 360 million
Total no. of shares pre acquisition = 360-137 = 223 million (FCX pre acquisition)
Market capitalisation of the acquiring firm = 223 million * 57.4 = 13 billion
approx..
When companies participating in the acquisition are from same sector it is called
a horizontal merger
Total offering = 25900 mn
Per share offering = 126.46
No. of shares of PD = 25900/126.46 = 204 mn shares outstanding
Market price per share (current) for PD = 126.46/1.30 = 97.27 per share
Market cap of PD = 204 * 97.27 = 20 billion approx.
Observation: Size does not matter in an M&A transaction if the capital markets
are at a matured stage
The financing can be arranged without much difficulty

Mode of funding: internal accounts + raise debt + raise preference or

convertibles
Pecking Order Hypothesis:
Bridge loan: temporary
An initial step in this financing was the joint commitment by JPMorgan and Merrill
Lynch to a combined $6 billion bridge loan prior to approval of the merger. FCX
announced on March 15 the pricing of a total of $17.5 billion in debt financing for
the Phelps Dodge acquisition, including $6 billion in high-yield senior notes
offered in the public debt market (the bridge loan would be drawn down only if
this public offering failed) and $10 billion in senior secured term loans. In
addition, a $1.5 billion senior secured revolving credit facility was provided,
which was to be undrawn at closing. The initial press release indicated an
offering of approximately 35 million shares of common stock and 10 million
shares of mandatory convertible preferred stock at $100.00 per share.
223 million shares existing
1. Shares offered to PD 137 mn
2. New issue of equity 47.15 mn
3. Convertible pref. stock 28.75 1.63 & 1.36

Session 7
Recap:
1 share of Target Company x shares of the acquiring company
1 share of target company = x rs.
1 share of target company = x rs + x shares of acquiring company
No of shares outstanding for acquiring and Target Company at the time of
acquisition
Value per share at the time of acquisition
Market capitalization of the two firms
No. of shares outstanding for Acquiring & target company at the time of
acquisition
Value per share at the time of the acquisition
Market capitalisation of the firm
Read:
FCX will acquire all of the outstanding common shares of Phelps Dodge for a
combination of cash and common shares of FCX for a total consideration of
$126.46 per Phelps Dodge share, based on the closing price of FCX stock on
November 17, 2006. Each Phelps Dodge shareholder would receive $88.00 per
share in cash plus 0.67 common shares of FCX. This represents a premium of 33
percent to Phelps Dodges closing price on November 17, 2006, and 29 percent
to its one-month average price at that date. The cash portion of $18 billion
represents approximately 70 percent of the total consideration. In addition, FCX

would deliver a total of 137 million shares to Phelps Dodge shareholders,

resulting in Phelps Dodge shareholders owning approximately 38 percent of the
combined company on a fully diluted basis. The boards of directors of FCX and
Phelps Dodge have each unanimously approved the terms of the agreement and
have recommended that their shareholders approve the transaction. The
transaction is subject to the approval of the shareholders of FCX and Phelps
Dodge, receipt of regulatory approvals and customary closing conditions. The
transaction is expected to close at the end of the first quarter of 2007. FCX has
received financing commitments from JPMorgan and Merrill Lynch to fund the
cash required to complete the transaction. After giving effect to the transaction,
estimated pro forma total debt at December 31, 2006, would be approximately
$17.6 billion, or approximately $15 billion net of cash.
Total offering made to PD (target firm) = 25.9 billion cash & stock
No. of shares of PD x offering per share = 26000 mn
Offering made per share = 126.46 = cash + stock = 88 + 0.67 stock of FCX
Offering made per share = 88 cash + 38.46 stock
38.46 = 0.67 shares of FCX
Value per share of FCX = 38.46/0.67 = 57.4 USD/share
No. of shares outstanding post acquisition = pre acquisition no. of shares +
shares offerd to the target company
% ownership offered (fully diluted) = 37%
Number of shares offered for 37% ownership = 137 million
Total no. of shares post acquisition = 137/0.37 = 360 million
Total no. of shares pre acquisition = 360-137 = 223 million (FCX pre acquisition)
Market capitalisation of the acquiring firm = 223 million * 57.4 = 13 billion
approx..
When companies participating in the acquisition are from same sector it is called
a horizontal merger
Total offering = 25900 mn
Per share offering = 126.46
No. of shares of PD = 25900/126.46 = 204 mn shares outstanding
Market price per share (current) for PD = 126.46/1.30 = 97.27 per share
Market cap of PD = 204 * 97.27 = 20 billion approx.
Observation: Size does not matter in an M&A transaction if the capital markets
are at a matured stage
The financing can be arranged without much difficulty
Mode of funding: internal accounts + raise debt + raise preference or
convertibles
Pecking Order Hypothesis:
Bridge loan: temporary
An initial step in this financing was the joint commitment by JPMorgan and Merrill
Lynch to a combined $6 billion bridge loan prior to approval of the merger. FCX
announced on March 15 the pricing of a total of $17.5 billion in debt financing for
the Phelps Dodge acquisition, including $6 billion in high-yield senior notes

offered in the public debt market (the bridge loan would be drawn down only if
this public offering failed) and $10 billion in senior secured term loans. In
addition, a $1.5 billion senior secured revolving credit facility was provided,
which was to be undrawn at closing. The initial press release indicated an
offering of approximately 35 million shares of common stock and 10 million
shares of mandatory convertible preferred stock at $100.00 per share.
223 million shares existing
4. Shares offered to PD 137 mn
5. New issue of equity 47.15 mn
6. Convertible pref. stock 28.75 1.63 & 1.36
The TED spread is the difference between the interest rates on interbank loans
and on short-term U.S. government debt ("T-bills"). TED is an acronym formed
from T-Bill and ED, the ticker symbol for the Eurodollar futures contract.
Eurodollar is one of the least regulated market and yet one of the most
competitive. Why?
Regulation has a cost.
Profile of the market: issuer and investor information asymmetry
PE market:

Regulation cost is reduced

Information asymmetry is low
Reduced regulation and hence deal closes faster.

Similarly in Eurodollar:

Investors are banks & hence better informed.

Session 10
Break up fee: COMPANY A is negotiating with company B and Almost close to
complete the deal. A C appears & offers a higher price to B If B decides to accept
the offer of C. C has to pay a break-up fee to A.
Fairness Opinion: Second opinion about valuation of the company
Using comparables, the valuation of the target:

Trading comps developed based on the market price

Transaction comps based on the precedent transactions

How to derive P/E multiple theoretically

Po = Do * (1+g) = BV * ROE
Ke-g
Po/Eo = (1-b)*(1+br)

Ke - br

Po/Bo = (Eo /Bo)* (1-b) * (1+br) = r * (1-b) * (1+br)

Ke-br

Ke-br

Here, r= ROE

Session 12
Capital Markets public, private
M&A FCX-PD, P&G, Gillette
Deal Structure, role of IBs, valuation issues
Leveraged Buyout
KKR
Acquisition using heavy amount of debt
Acquisition + Leverage LBO
FCX Strategic Buyer
P&G Strategic Buyer
Inorganic Growth
KKR Buying out dollar general Dollar store
KKR Buying out RJR NABISCO Tobacco + Food Business
Junk Bond Market LBO Michael Milken Junk Bonds King
KKR like firms Financial Investors
PE player Financial Investor
Enter with an investment
Exit at a higher multiple
100 300/500/600
Dollar General in profits some trouble
RJR NABISCO in profits some trouble
BARBARIANS AT THE GATE
Any firm in trouble - Valuation undervalued takeover target
Strategic Investor/ Financial Investor
Synergies converted into value in the long run
Agency theory owner management conflict corporate governance

Shareholder Value Creation

Agency Theory
Owners are principals & Managers are Agents
Michael C Jensen
Eugene Fama
Williamson
Ronald Coase
Financial markets invisible hand
Targets: RJR NABISCO tobacco + food business
Problems Fixable
1. ROA Down
2. Inventory Turnover Down
Low Capital Expenditure to Sales Ratio 7%
Low NWC to Sales Ratio - Low
LBO Target
Finance the target with heavy debt low equity
Buy the entire equity & make the firm delisted going private
Buy back reverse book building
Control of the financial investors
Repay the debt over a period of time
The target has fixable problems Fix them
Improve the performance metrics
Improved free cash flow available to pay debt

FCFF available from the target reduce the debt increase the equity exit with
a higher multiple
Alpha Seekers PE/HF
Market Neutral Investors
RECAP AS ON 18TH OCTOBER 2015:
1. CAPITAL MARKETS- PUBLIC & PRIVATE
2. M&AS- FCX- PD; P&G- GILLETTE
3. DEAL STRUCTURE, ROLE OF IBS, VALUATION ISSUES

LEVERAGED BUYOUT

1. ACQUISITIONS USING HEAVY AMOUNT OF DEBT

2. ACQUISITIONS+LEVERAGE LBO
3. FCX AND P&G ARE STRATEGIC BUYERS, IN THE SAME LINE OF BUSINESS
AND IS NOT INTENDED TO EXIT
4. BOTH INTEND TO HAVE INORGANIC GROWTH, HAVING SYNERGY IN
OPERATIONS EXPANDING THE GEOGRAPHIC COVERAGE
5. FOR LBO, KKR IS NOT BRINGING ANY RESOURCES OTHER THAN CASH, NO
VALUE ADDED IN SYNERGY
6. KKR- BUYING OUT DOLLAR GENERAL- DOLLAR STORE
7. KKR- BUYING OUT- RJR NABISCO TOBACCO+ FOOD BUSINESS
8. LBOS ARE MOSTLY POPULAR IN USA- RAISING RISKY DEBT
9. JUNK BOND MARKET- LBO- MICHAEL MILKEN- JUNK BOND KING
10.KKR LIKE FIRMS- FINANCIAL INVESTORS
a. ENTER AN INVESTMENT WITH A TARGET IRR
b. EXIT AT A HIGHER MULTIPLE
c. 100- 300/500/600
11.BARBARIANS AT THE GATE
12.DOLLAR GENERAL- IN PROFITS- SOME TROUBLE
13.RJR NABISCO- IN PROFITS- SOME TROUBLE
14.ANY FIRM IN TROUBLE- VALUATION IS AT STAKE- UNDERVALUED- BECOMES
A TAKEOVER TARGET
15.UNDER THE SIGHT OF STRATEGIC INVESTOR/FINANCIAL INVESTOR
16.FINANCIAL INVESTOR WILL TAKEOVER ADD SOME VALUES AND EXIT AT
RIGHT TIME
17.SYNERGIES- CONVERTED INTO VALUE IN THE LONG RUN
18.AGENCY THEORY- OWNER MANAGER CONFLICT- CORPORATE
GOVERNANCE- SHAREHOLDERS WEALTH CREATION
19.AGENCY THEORY
a. OWNERS- PRINCIPAL
b. MANAGERS- AGENTS
20.IMPORTANT ADVANTAGE OF LBOS IS IT REDUCES AGENCY CONFLICTS
21.MICHAEL C JENSEN, EUGENE PHARMA, WILLIAMSON, RONALD COASE
THEORIES DEAL WITH THIS ISSUES
22.FINANCIAL MARKETS- INVISBLE HAND- M&A- FAILED FIRMS WILL BE TAKEN
OVER BY SUCCESSFUL FIRMS

23.CCD IPO ISSUE:

24.TARGETS- RJR NABISCO- TOBACCO+ FOOD BUSINESS

25.PROBLEMS: FIXABLE
a. ROE- DOWN
b. ITR- DOWN
26.FOLLOWING MAKES LBO TARGET
a. LOW CAPITAL EXPENDITURE TO SALES RATIO- 7%
i. MAYBE ALREADY HAVE BUILT ENOUGH CAPITAL
b. LOW NWC TO SALES RATIO
27.HOW LBO OPERATES?
a. FINANCE THE TARGET WITH HEAVY DEBT LOW EQUITY
b. BUY THE ENTIRE EQUITY AND MAKE THE FIRM DELISTED- GOING
PRIVATE
c. BUYING BACK- REVERSE BOOK BUILDING
28.CONTROL OF THE FINANCIAL INVESTOR INCREASED
29.REPAY THE DEBT OVER A PERIOD OF TIME
30.FIX THE PROBLEMS OF THE TARGET WHICH HAS FIXABLE PROBLEMS
31.IMPROVE THE PERFORMANCE METRICS
32.TARGET- IMPROVE THE FREE CASH FLOW AVAILABLE TO PAY DEBT
33.FCFF AVAILABLE FROM THE TARGET- REDUCE THE DEBT
34.INCREASE THE EQUITY VALUE- EXIT AT HIGHER MULTIPLE

35.EXAMPLE- BAIN CAPITAL MITT ROMNEY, COMPETING IN US ELECTIONS

36.ALPHA SEEKERS- AIM TO GENERATE RETURNS GREATER THAN THE
MARKET, IRRESPECTIVE OF HOW THE FIRM IS OPERATING

37.LBO OBJECTIVE: PAYDOWN DEBT DURING HOLDING PERIOD

a. INITIAL ACQUIRED FOR 8.0x LTM EBITDA OF $125
b. FUTURE: SOLD FOR 8.0x LTM EBITDA, REFER LBO MODELLING
FROM BOOK
38.
TASKS:
a. USING COMPS ARRIVE AT EQUITY VALUE PER SHARE OF A
COMPANY
b. PERFORM VALUATION OF KKR- RJR LBO

Session 13
LBO:
1. What is an LBO?
Cash Based acquisition funded by large amount of debt at varying interest
rates and with different kinds of debt structures.
i.
FCX-PD (a kind of LBO)
ii.
KKR-DG
iii.
KKR-RJR NABISCO

2. What
a.
b.
c.
d.
e.
f.

are the characteristics of typical LBO candidate?

The firm is not doing well? ROI, ITR, ATR
Firm has lot of asset built-up: Fixed assets, brands, WC
The assets can be disposed-off, can be used as collateral
Asset Stripping
The firm is undervalued in the market
The shareholder group is not diverse

3. What
a.
b.
c.
d.
e.

is the business model of a buyout firm?

Identify a target with LBO characteristics
Have access to sources of funding
The target has a potential value if turned around
Infuse large amount of debt into BS
Pay the existing owners through cash and delist the target (This is
done to gain free ride with regards to decision making like getting
rid of emotionally attached businesses etc)
Improve the targets performance generate free cash flow
Deliver the target over a period of time increase the value of
equity exit
Exit: take the firm public & go for OFS (offer for Sale) or sell a part
or whole of the firm to another buyout firm to another strategic
investor for a better premium
Reason for exiting coz a buyout firm is a financial investor and
hence would like to exit at the end of your investment horizon.

f.
g.
h.
i.

Increase Value by:

Only by deleverage
EBITDA expansion
EBITDA expansion, multiple expansion , deleverage

Price = EPS * P/E

EPS represents performance & P/E represents perception get paid to talk
Call transcripts
CFOs Presentation
Communication cost to capital markets
All these are done to improve the P/E expansion by improving perception
about the firm

CAPEX equals Depreciation only for firms that already have a lot of asset built-up
and is not technology oriented so does not need constant upgrade. Then all you
are left with is maintenance CAPEX which can be met with cash available. If you
have growth capex then you have to improve cash flows a lot. IF you only have
maintenance CAPEX to bother with then all you have to do is improve the
turnover to improve the free cash flows.

Debt Capital Markets

Types of Debt: Public capital markets/ Private Capital Markets Term Loan Private
Placement
Interest Rates: Fixed / Floating
Location: Domestic, International, Euro, Global
Convertibility: FC, PC, NC
Bonds with call & Put

Credit Rating Advisory

Valuing Debt Instruments and working on the yield Curve
Understanding & interpreting the yield curve

Yield Curve as leading indicator

Yield Curve: Yield vs maturity shape:
1. Normal Yield Curve:
Short Run Interest Rates < Long- Run Interest rates
2. Inverted Yield Curve:
Short-Run Interest rates > Long-run Interest rates
3. Flat Yield Curve

Term Premium:
Yield = base rate + term premium
Liquidity preference/ Expectations/ Preferred Habitat/ Segmentation Theory
Yield to value a bond:
1. Yield to maturity
Face Value: 10000
Maturity: 8
Coupon: 9%
YTM: 10% (Intermediate coupons are reinvested at YTM till N)
Value: Price (1, 2, 3, 4, 5)
Checklist:

Yield Curve interpretation shape & direction: shape as a predictor of

future economic outlook
Parallel shift in the yield curve
Yield pick up

DB research division
In-house research division

A trade in a direct fashion trading

Advising: a client; in-house trading desk monetise the idea or information

Information: Arbitrage relative value trades is nothing but finding out arbitrage
in the bond markets
Arbitrage is a short run phenomenon
Relative value trade: arbitrage derived from yield curve data
Boot strapping model
Cubic spline model
Affline model
NSE uses NS model: Nelson-Siegel Model (ZCYC): ZCYC Zero Coupon Yield
Curve
9th November:
Recap:
ECM: Primary/IPO/Offer for sale
Public capital markets, Pvt capital markets
MOFSL case, Indigo, CCD

M&A: FCX-PD, PG-Gilette; LBO-RJR-KKR; Dollar General-KKR

The revenue model for IBS
FICC: Fixed Income, Currency, commodity
DB Relative Value Trades: ZYCC Using Boot Strapping
NSE: Nelson Siegel Model For ZCYC
Actual Yield Vs Predicted Yield: Trading Strategy

INTEREST RATE SWAP:

An Agreement between two parties
To exchange interest on a notional principal
Fixed rate for floating rate

Objective:
a) To transform a liability from FL to fixed or vice versa
b) To reduce the borrowing cost

Questions:
1. What is the requirement for BFG & Rabobank?
2. What is the IRS structure designed by the IB?
3. What will be the all-in-cost to BFG, if it enters into IRS?

BFG:

INDUSTRIALS USA
LOSSES
BBB RATING FALL
50 MILLION USD FUND
MT TO LT
PREFERABLE INTEREST FIXED
12.50%

RB:

DUTCH AG BANK
POSITIVE PROFILE
50 MN USD FUNDS
AAA RATED
EURO DOLLAR MARKET
RATE APPLICABLE : L+25
FLOATING RATE PREFERED MODE

INTERMEDIARY:

MARKET MAKER
BENEFIT FROM FEES & ARBITRAGE PROFIT SPREAD
FACE LIQUIDITY & COUNTERPARTY RISK

INTEREST RATE SWAP:

REDUCE THE BORROWING COST

FACILITATE CONVERSION FROM FIXED TO FLOATING AND VICE VERSA

FIXED RATE
FLOATING

AAA (1)
10%
L+50

BBB (2)
12%
L+100

REQUIRED
ALL INTEREST COST
-

FLOATING
L-25

FIXED
11.25 % (12- 0.75)

FIRST CASE HAS DIFFERENCE OF 200 BP

SECOND CASE HAS 50 BP DIFFERENCE
OVERALL TRANSACTION INVOLVES 150 BP(QSD- QUALITY SPREAD
DIFFERENTIAL), IF SHARED EQUALLY WILL HAVE: (IF NO INFO, MAY NOT
SHARE EQUALLY)
o BENEFITS FROM IRSWAP:
75 BPS IN FLOATING AND 75 BP IN FIXED MODE
A IS HAVING BOTH COMPARATIVE AND ABSOLUTE ADVANTAGE OVER B BUT
MORE BENEFIT IN FIXED RATE MARKET
B IS PAYING MORE IN BOTH THE MARKETS AND PREFERS FLOATING
MARKETS
1 GOES TO FIXED RATE MARKET AT 10% BORROWING HAVING
COMPARATIVE ADVANTAGE
2 GOES TO FLOATING RATE MARKET AT L+100 RATE

10%

FLOATING RATE

L+100
PARTY 2

PARTY 1
FIXED RATE

1 PAYS FIXED AT FIXED AND GETS FIXED FROM 2. 2 PAYS FLOATING AND
GETS IT FROM 1

AT 1: INFLOW EQUALS OUTFLOW

L-25 = 10% - (10.25%) +L -> ONLY CONDITION WHICH SATISFIES THE
EQUATION. HENCE FIXED RATE ARRIVING AT 1 = 10.25%
FOR 2: 11.25 = L+ 100 L + 10.25

INCLUSION OF INTERMEDIARY:
SL NO
1
2
-

FEES COST
L+50-75
12-0.75

INTERMEDIARY
15
15

REVISED RATE
L+50- 60
12.00- 0.60

BECAUSE OF INTERMEDIARY
o AT 1:
OUTFLOW : 10% & L
INFLOW: 10.10 FLOATING RATE
o AT 2:
OUTFLOW: L+100 & FLOATING RATE OF 10.40
INFLOW AT L
PARTY 1

INTERMEDIARY

PARTY 2

BFG HAS FLOATING RATE AND NEEDS TO TRANSFORM IT TO FIXED RATE

LIABILITY AND OBJECTIVE SHOULD BE IT IS LESS THAN DIRECT MARKET
TRANSACTION AROUND 12 TO 13%
RB TRANSFORM A FIXED RATE LIABLITY INTO A FLOATING RATE LIABILITY
AT A COST LESS THAN L+25
HENCE IT FACILITATES TWO THINGS
o TRANSFORMATION
o REDUCTION OF COSTS

CASE TRANSFORMATION:

L+50

5.5 MN (11% OF 50)

INTERMEDIA
RY
L- X

11%

11%
2

L- X

L+50 BPS (L-X) +11%= 11% + (50+X)= 11.5% + X

FOR RB: 11% - (11%) + L-X = L-X

WHAT IS MAXIMUM VALUE OF COST?

-

BFG: X CANNOT BE GREATER THAN 100 BPS AS OVERALL RATE REQ IS

12.5%
RG: X CANNOT BE MORE THAN 100 BPS (INCLUDING OTHER COSTS PAID
BY RG)

RaboBank has a competitive advantage in both the fixed and floating markets. But
Rabo has a comparative advantage in the fixed rate market & BFG has a
comparative advantage in the floating rate market. So, RB goes to fixed rate market
and BFG to floating rate market.
Next day:
Alternate market for investment
-

The capital is available with firms or high net worth individuals

There is a need to generate above market returns and market neutral returns
Alpha seeking behaviour : PE, VC, HF- alpha services
High levels of RISK and high levels of return

Expectations of moderate to high levels of IRR

-

Short investment windows

Quick entry and exit
Expansion of multiples
Active participation in start-up and mezzanine funding

Valuation industry
-

Investments of PE
Valuations are quite high: Real estate, Dotcom, E-Com
Market correction
Valuations are justified as long as the investor is able to exit at a better price
with a premium

Valuation
-

Implied value=Investment amount/ stake is critical so is the IRR

VALUATIONS ARE JUSTIFIED AS LONG AS THE INVESTOR IS ABLE TO EXIT AT

A BETTER PRICE
Strong Tech Platform- Investment
Marketing in Form Structure
Logistics India Past
Pref. Merchandising Banking Network COD e-trailing Co.
Aggregation + Investing
Supplier Fulfilled means: This means that this trip is listed by a supplier on the
website. It will be executed by the supplier and Thrillophilia is a booking and ticketing
partner for it.
E-Com Model
-

Strong technology platform- requires high investment

Market traffic doesnt increase linearly, needs strong infra to withstand
Marketing Infrastructure
Strong logistics
Payment mechanism (strong contributors)
For last mile delivery in rural areas, partnering with India Post- Logistics
GMV= Aggregation + Inventory

Innovations on Wall Street

1. ML for EK- 6 plan vanilla products
2. SB design of IRs for BGF and RB
-

Reduce the cost of borrowing by a few basis points

Exploit the arbitrage opportunities even at the minutest level in the form
interest rate differentials

CDO (Collateralized Debt Obligations) & CDS (Credit Default Swaps) Financial
weapons of mass destruction

Wall street- Greed is good

-

There is a continuous pressure from the clientele to deliver consistent profits

Arbitrage opportunities are gradually disappearing
Global connectivity of markets and financial globalization/ democratization of
markets
If there is capital available it is equally accessible to all investors
o To meet clients requirements
o To meet their proprietary trading objectives
HFT- High frequency trading
Alpha generating- returns irrespective of market movements
1. Futures, Options, Swaps, Floors, Collars, CAPS
2. Currency swaps, interest rate swaps, zero coupon swaps
3. Spread trading strategies
4. CDO/CDS family
Objectives:
o Liquidity generation
o Generating profit out of arbitrage

CDO exercise:
1. Expenses:
a. DO1: 80 million X (L+70 BPS)
b. DO2: 10 mn x 9%
c. IRS: 80 mn X 8%
2. Income:
a. Collateral: 100 mn
b. Rate: 11%
c. Value: 11 mn
d. IRS: 80 mn x L
3. Equation:
a. 100mn X 11% + 80 mn X L ( 80 mn* (L+70) + 10 mn X 9% + 80 mn X
80%):
b. Which equals:
= 11+ 80 L 80 L- 0.56 - 0.9 -6.4
= 3.14 mn gross return to equity tranche/ Sponsoring SPV
c. Less: Collateral Management expense: 0.5
d. Net return by sponsor: 10
e. Net return to equity investor: 0.264
(Difference between interest income on collateral and interest expense on Debt
obligations)
f. ROE: 26.40%

4. Assumptions:

a. No default
b. No prepayment
Investment Banks help clients to generate funds and to restructure, to manage
funds/ portfolio and to face the market fluctuations with risk management instruments
and to innovate financial products.

Portfolio: Investment
Typical fund management consists of building a portfolio/Initial NAV/ Track the
portfolio/ how the NAV is changing and what are the return
Investment Banking: Intermediation POV
Equity/Debt/PE/VC/HF
Portfolio Beta = Market Beta
Cash + Beta + Alpha = is the return you get from the hedge funds
Inside Job
RISK TAKERS Continuous search for positive returns innovation exploiting
arbitrage
HF industry
How hedge funds are different from mutual funds?
Total cost of funding: Cost of money + Intermediation Cost + Regulation
GRC: Governance+ Risk+ Compliance Cost

Amaranth Advisors LLP

6 Billion USD in 30 days
Hedge funds are alpha seeking or market neutral firms
Fee 2/20
Betting on energy futures
MtoM
LTCM convertible bond arbitrage
Amaranth
Ending Value = Initial Investment * (1+return on
investment)
Assumption made: Beta of sector same as sector

shares in the portfolio

Sectoral index return = portfolio return for sector
Cash assumed to remain same
Unlisted Bonds remain same
Listed bonds valued at market value at current yield
Holding Period Return = (CF + Cap appreciation)/initial
investment*100

Expense ratio = total expenses/ (average of initial value & ending value)
DRI-dividend reinvestment plan means dividend calculated on face value is used to
buy addl units on NAV on dividend date to reinvest.
Bonus ratio if 1:6 means 1 new unit for 6 exiting units

Addl units under bonus plan = existing units / 6 if bonus ratio is 1:6