The International Financial Markets The Global …people.stern.nyu.edu/igiddy/gbcmreview1.pdfl Domestic and International Money Markets l Domestic and International Capital Markets

Giddy Global Banking: Review I/1

Global Banking&

Capital MarketsREVIEW I

Prof. Ian GiddyStern School of Business,

New York University

Copyright ©1999 Ian H. Giddy International Financial Markets 2

What is Global Banking and CapitalMarkets?

The International Financial Markets

uMoney and foreign exchange;

derivatives; international bonds &

equities; loan trading

l The Global Banking BusinessuLending; trading and transactions;

underwriting; M&A; project financing;asset management; advisoryservices; etc



What are the Global Financial Markets?

l The Foreign Exchange Market

l Domestic and International Money Markets

l Domestic and International Capital Markets

l The Derivatives

l International Equity and M&A

l Using the Global Capital Markets: GlobalBanking Strategy and Implementation


Where the Eurocurrency Market Fits In

US Domestic German

Market EUR0CURRENCY MARKET Domestic Market

Euro-Deutsche Mark

Eurodollar Market

Market Foreign

Exchange

Market Japanese

Euro-Yen Domestic

Market Market

Euro-Commercial Euro-Floating Rate Straight

Paper Market Note Market Eurobond Market



Interest Rate Linkages in theInternational Money Market

Two stories to tell:l Domestic vs. Eurol Eurocurrency A vs. Eurocurrency B

Domestic Market A The Euromarkets Domestic Market B

Trea- Bank Euro Euro Bank Trea- sury Deposit Deposit Deposit Deposit sury Bill Market Market Bill

Trea- Corp- Euro Euro Corp- Trea- sury orate Bond Bond orate sury Bond Bond Market Market Bond Bond

Global Banking:Products and Customers

Prof Ian Giddy

Stern School of Business

New York University



Products or Customers?

Sales

CapitalMarkets

CorporateFinance

Customer-DrivenInnovation


Client-Arena-Product Matrix

Pro

du

cts

off

ered

Clients servedMarkets covered



Products

l Credit productsl Trading and positioningl Risk management productsl Financial engineering and structured

financel Underwriting and distributionl Asset managementl Retail and private client servicesl Transactions services



Pro

du

cts

off

ered


Build versus buy?




Pro

du

cts

off

ered


Example: SBC and US bank equity



Pro

du

cts

off

ered


Sell? (NatWest)



NatWest Bank?

NatWest BankClients

Corporations Government Institutions High net worth RetailProductsSecurities custody x xAsset Management x x xPrivate Equity xInsurance x xLending x x x xDeposits x x x xSecuritization/Structured and Project Finance x xEquity underwritingBond underwritingMergers and AcquisitionsCredit cards x x xTrading - Money market x x - FX and derivatives x x - Interest rate derivatives x x - Bonds x x - Securitized products x x- Futures x xMortgages xStock brokerage x xCorporate Advisory xPrivate Banking x


To Succeed,Analyse the Industry Structure

COMPETITIVEADVANTAGE

SUBSTITUTES

CUSTOMERS

BARRIERSTO ENTRY

SUPPLIERS



Product Profitability Cycle

Excess returns

Time


New Financial Products:Economics of Financial Innovation

l Certain kinds of market imperfectionsallow hybrids to flourish

l But innovation are readily copied; so onlycertain kinds of firms can profit frominnovations.

l There is a product cycle and profitabilitycycle of innovations.



Financial Innovations:What to Look For

l Reallocating riskl Increasing liquidityl Reducing “agency costs”l Reducing transactions costsl Reducing issuers’ or investors’ taxesl Circumventing regulationsl Circumventing internal constraints


Battle Mountain Gold

$300/oz = Cost of Production

Forward Prices for Gold

$400

$450

$425

Each year, BMGchooses toproduce if P>300defer if P<300



Principles of Innovation ThroughFinancial Engineering

l Bundling and unbundling basic instruments

l Exploiting market imperfections (sometimestemporary)

l Creating value added for investor and issuerby tailoring securities to their particularneeds

Key: For the innovation to work, it mustprovide value added to both issuer andinvestor.


Asset Securitization

CHASE (SPONSOR)

SPECIALPURPOSEVEHICLE

CREDIT CARDRECEIVABLES

ISSUESASSET-BACKEDCERTIFICATES

SALE ORASSIGNMENT

CREDIT CARDRECEIVABLES



Example

Dayton Hudson Credit Card Maste r Trus t, Series 1995-1

Is s ue Date : 9/13/95Expe c ted Maturity: 2/25/2002Structure : Senior/Subordinated, sequential payS e lle r: Dayton Huds on Receivables CorporationCards: Private label cards for Mervyn's, Target and Dayton's Department StoreS e rvicer: Retailers National BankUnde rwrite r: Firs t Bos ton Corporation

Tranche Face Value Coupon Ave. Life RatingDe s c ription PlacementA $400 million 6.10% 3 Years AAA Senior PublicB $123 million 0.00% 3 Years AAA Subordinated Private

Collate ral Information Yie ld on portfolio 22.52% His torical yield after delinquencies 18.90% Number of accounts 22,796,667 Overcollateralization of A Tranche 23.50% Largest geographic concentration California (24.9%)


l Does the originator currently face a high cost offunding assets that would be recognized as sound,cash-generating assets if taken in isolation?

l Does it have a regulatory or capital constraint thatmakes freeing up the balance sheet important?

l Does it have data about the assets (required by ratingagencies and financial guarantors)?

l Does it have the servicing process and systems thatcan meet the more demanding standards of the asset-backed market?

l Is the originator willing to undertake a complex, time-consuming transaction to obtain a broader, potentiallycheaper, ongoing source of funding?

Is the Company Ready for ABS?



Finance Co. Ltd(Seller)

FCL 1997-A(Special Purpose Co.)

Investors

Financial GuaranteeProvider

Monthly HPPayments

GuaranteeResponsibilities

TrusteeTrustee

Responsibilities

Monthly ABSPayments

Servicing Fees

Finance Co.’sCustomers

Hire-PurchasePayments

Case Study: Ongoing Payments


Project Financing

Definitionl Lending to a single purpose entity

for the acquisition and /orconstruction of a revenue-generating asset with limited or norecourse to the sponser

l Repayment of the loan is solelyfrom the revenues generated fromoperation of the asset owned bythe entity

l Security for the loanu the revenue generating assetu all shares and interests in the

entityu real propertyu all contacts, permitsu authorizations, etc.; and,u all other instruments necessary for continuing project

operations



Project Financing

Definitionl Lending to a single purpose entity

for the acquisition and /orconstruction of a revenue-generating asset with limited or norecourse to the sponser

l Repayment of the loan is solelyfrom the revenues generated fromoperation of the asset owned bythe entity

l Security for the loanu the revenue generating assetu all shares and interests in the

entityu real propertyu all contacts, permitsu authorizations, etc.; and,u all other instruments necessary for continuing project

operations

StepsProject Identification

& Resource Allocation

Risk Allocation &Project Structuring

Bidding & MandatingContracts

Due Diligence &Documentation

Execution & Monitoring

Construction Monitoring

Term Loan Conversion& Ongoing Monitoring


Sample Structure

Sponsors /Shareholders

SINGLE PURPOSEPROJECT COMPANY

EquipmentSupplier

Contractor

Feed Stock(e.g., fuel)Supplier

Warranties and Supply Agents

Operator

TurnkeyConstruction

Long TermAgreement

Operations &Maintenance Mgmt

Purchaser

SyndicateBanks

Other ProjectParticipants:

Currency and InterestRate Hedge Providers

Multilaterals and EDA’s

Legal Counsel

Technical Consultants

Offtake (e.g,power purchase)Agreement

ArrangingBank


Ras LaffanLiquified Natural Gas

Korea Gas

Security Trustee(New York)

Bondholders

Mobil QM(Mobil Corp.)

Qatargas(State of Qatar)

Joint venture agreement

30% 70%

ContractorsContractors

Contractors

LNG

LNGpayments

Debt servicepayments

Residualpayments

Contractpayments

BanksExport Credit

Agencies

Debt servicepaymentsRas Laffan


Martell

l Martellufamilyuother shareholders

l Seagramsl Grand Met

Concept: What are the goals and tacticsof each in this ownership transfer?



Goals of Acquisitions

Rationale: Firm A should merge with Firm B if[Value of AB > Value of A + Value of B + Cost of transaction]l Synergy

u Eg Martell takeover by Seagrams to match name and inventory withmarketing capabilities

l Gain market poweru Eg Atlas merger with Varity. (Less important with open borders)

l Disciplineu Eg Telmex takeover by France Telecom & Southwestern Bell

(Privatization)

u Eg RJR/Nabisco takeover by KKR (Hostile LBO)

l Taxesu Eg income smoothing, use accumulated tax losses, amortize goodwill

l Financingu Eg Korean groups acquire firms to give them better access to within-group

financing than they might get in Korea's undeveloped capital market


Fallacies of Acquisitions

l Size (shareholders would rather havetheir money back, eg Credit Lyonnais)

l Downstream/upstream integration(internal transfer at nonmarket prices,eg Du Pont/Conoco, Pru/Bache)

l Diversification into unrelated industries(Kodak/Sterling Drug)



Using The Restructuring Framework($ Millions of Value)

RestructuringFramework

1

2

CurrentMarketPrice

3

Optimalrestructuredvalue

Potentialvalue withinternaland externalimprovements

Potentialvalue withinternalimprovements

Companyvalue as is

Maximumrestructuringopportunity

Financialengineeringopportunities

4

Disposal/Acquisitionopportunities

Strategicand operatingopportunities

CurrentperceptionsGap: “Premium”

5

$ 25

$ 975

$ 300

$ 1,275$ 350

$ 1,625

$ 10

$ 1,635

$ 635

$1,000

Eg Increase D/E


Mergers and Acquisitions: Summary

l Mergers & Acquisitionsl Divestituresl Strategic Alliances

Concept: Is a business worth morewithin our company, or outside it?



Martell -- The Conclusion


M&A Advisory Services:1. Role of the Seller's Advisor

l Develop list of buyersl Analyze how different buyers would evaluate companyl Determine value of the company and advise seller on

probable selling price rangel Prepare descriptive materials showing strong pointsl Contact buyersl Control information processl Control bidding processl Advise on the structure of the transaction to give value to

both sidesl Ensure all nonfinancial terms are settled earlyl Smooth postagreement documentation



M&A Advisory Services:2. Role of Buyer's Advisor

l Thoroughly review target & subsl Advise on probable price rangel Advise on target's receptivenessl Evaluate target's options and anticipate actionsl Devise tacticsl Consider rival buyersl Recommend financial structure and plan financingl Advise on initial approach and follow-upl Function as liasonl Advise on the changing tactical situationl Arrange the purchase of shares through a tender offerl Help arrange long term financing and asset sales


Alliance Capital

l Trends in the business?l Global business?l Continue “active growth” management?l Competition?l Fees?



Portfolio Performance Evaluation

l How well did the portfolio do?l How do we adjust for risk, to compare

different managers?l Why?uRisk

uTiming

uAsset allocation

uSecurity selection


Global Brivate BankingKey Issues to be Addressed

l Personal, family, business andpolitical/economic context

l Personal Investment Portfoliol Personal Retirement Plansl Insurancel Estate Planningl Businesses



Private BankingIndividual Solutions

Your Needs

Real Estate

Partnerships

Fine Arts

Transfer of Wealth

Liquid assets and securities Account Management

Real Estate Advice

Structured Finance

Art Consulting

Estate- and Trust

Management

Relationship--Manager

Matching your Needs

with our Expertise

Overview Private Financial Planning

Translation by our Specialists


Optimizing asset structure and taxminimization opportunities

create enjoy

entrepreneurship retirement estate

Assets accumulated

Proceeds from selling the business

financial portfolio

real estateinvestment

pension plan

health insurance

?

share transfer



Global Private Banking

l Client needsl Provision of services to meet needsl Where does the bank excel?

l Add value to the relationship by buildingfrom asset management to familyfinancial planning and family-ownedinvestment banking services


After Glass-Steagall

WholesaleRetail

Insurance

Asset Management

Universal Banking?



Citigroup

l Buy? Sell? Hold?l What’s unusual about the deal?l Will the combination produce net

positive economic value?l From where? Who will get it?l How long before gains realized?l Risks that the deal will fall through?


Valuation: The Key Inputs

l A publicly traded firm potentially has an infinite life.The value is therefore the present value of cash flowsforever.

l Since we cannot estimate cash flows forever, weestimate cash flows for a “growth period” and thenestimate a terminal value, to capture the value at theend of the period:

Value = CF

t

(1+r)tt =1

t =∞∑

Value = CFt

(1+r)t+

Terminal Value

(1+r)Nt =1

t=N∑



Models of Valuation

Choose aCash Flow Dividends

Expected Dividends to

Stockholders

Cashflows to Equity

Net Income

- (1- δ) (Capital Exp. - Deprec’n)

- (1- δ) Change in Work. Capital

= Free Cash flow to Equity (FCFE)

[δ = Debt Ratio]

Cashflows to Firm

EBIT (1- tax rate)

- (Capital Exp. - Deprec’n)

- Change in Work. Capital

= Free Cash flow to Firm (FCFF)

& A Discount Rate Cost of Equity

• Basis: The riskier the investment, the greater is the cost of equity.

• Models:

CAPM: Riskfree Rate + Beta (Risk Premium)

APM: Riskfree Rate + Σ Betaj (Risk Premiumj): n factors

Cost of Capital

WACC = ke ( E/ (D+E))

+ kd ( D/(D+E))

kd = Current Borrowing Rate (1-t)

E,D: Mkt Val of Equity and Debt

& a growth pattern

t

g

Stable Growth

g

Two-Stage Growth

|High Growth Stable

g

Three-Stage Growth

|High Growth StableTransition


Client-Arena-Product Matrix:Citigroup

Pro

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off

ered




Complementarity and Cross-Selling

WholesaleRetail

Insurance

Asset Management

Citigroup?

Documents

The International Financial Markets The Global …people.stern.nyu.edu/igiddy/gbcmreview1.pdfl Domestic and International Money Markets l Domestic and International Capital Markets