Essential Career Skills for Investment Banking and Finance.pptx

Banking Investment

1. Essential Career Skills for Investment Banking and Finance WELCOME TO NEW YORK INSTITUTE OF FINANCE'S COURSE ON ESSENTIAL CAREER SKILLS FOR INVESTMENT BANKING AND FINANCE Thank you for joining us - We are so excited to have you here! If this is your first time taking a course on this platform, you may want to enroll for a short demo course created by edX to orient learners like you. This demo course can be accessed  here .  This demo course from edX is available any time, and you will need to spend no more than 15 Minutes in it. So, spend some time to get familiarized with the platform and be well prepared to experience our course on Essential Career Skills for Investment Banking and Finance What you need to know about this course on Essential Career Skills for Investment Banking and Finance? It is a self-paced course, so once enrolled you are free to move through the material any time that suits your schedule, and from any location that enables internet connectivity. This course comprises 11 modules. Each module is comprised of a series of video lectures by our instructor – Jerome Wong. The total duration of this course is approximately 7 hours. There's a community recommendation section in this course which allows students to exchange interesting articles and resources related to the topic with each other. This course is part of NYIF's Investment Banking Certification. To learn more about this professional certificate, click  here . To find out how you can master the essential career skills for investment banking from this course and expand your skill set by completing the Investment Banking Certification from the New York Institute of Finance, contact [email protected]. Need Support? Teacher’s and technical assistance is available via the discussion forum, just post a question and we will respond within 2-3 business days

2. Contents 1. Getting Started 2. Investment Banking 3. Buy-Side Institutions 4. Alternative Investments 5. Related Finance Opportunities 6. Career Prep Strategies 7. Overcoming Generational Stereotypes 8. Your Authentic Story 9. Your Personal Brand 10. Cover Letters/Emails 11. Elevator Pitch 12. Impact Interviewing 13. Final Exam 14. Congratulations 15. Community Recommendation

3. 1. Getting Started

4. 1. Getting Started Welcome to New York Institute of Finance's Course on Essential Career Skills for Investment Banking and Finance! We at NYIF are so excited to have you here. This flexible, self-paced digital course can be completed at your leisure. If this is your first time taking a course on this platform, you may want to enroll for a short demo course created by edX to orient learners like you. This demo course can be accessed  here . This free demo course from edX is available at any time, and you will need to spend no more than an hour in it. So, spend some time to get familiarized with the platform and be well prepared to experience our course   on  Essential Career Skills for Investment Banking and Finance . We hope that you enjoy and gain the most out of this course. Kind regards, The NYIF Team

5. About the Course By the end of this course, you will be able to: Engage with industry professionals like an experienced practitioner. Expand your knowledge of the various financial institutions. Learn the jargon (i.e. private bank vs. private equity vs. private placement vs. private side). Find your professional fit. Elevate your EQ.

6. Course Overview The goal of the course is about increasing your financial fluency, is to understand when people talk about all different aspects of the financial world and I think part of the goal is to kind of expand your understanding of what that can encompass. The world is much bigger than bulge bracket Wall Street firms. There’s a lot more opportunities around the world in different companies as well as different functions that we’ll be going over and like a lot of this is 80% is knowing jargon and jargon gets recycled. I’ll give you a little bit of history, so we could and then more experienced people you talk to and they use all the terms which is newer terms then you'll get an idea of what they’re talking about. And the second half of the class it’ll be about how to develop your own career. What it takes to get a job and a lot of it is what people really look for and it's much beyond what I describe the boy scout traits. Yes everyone looks for smart, hard-working people, okay move on. What differentiates you from that? So I'm going to teach stuff that I think from a very sales perspective because there isn't a day whether you’re looking for a job, you're trying to convince your boss for a project. Trying to convince clients. You’re trying to convince your kids to brush their teeth. It's all about sales.

7. Course Overview I’ll go specifically over different sectors and what kind of focuses are and the skill sets and what the job is like, so you’ll get a better idea because the definition of fit for both the company you're going after as well as the role is a alignment of priorities, okay. What people are willing to put in together as a team to succeed. Alignment of interest is simple, we all want to make money, we all want to have a good that's that's an overgeneralization. What you want to look for is that people are willing to be in the trenches with you to put in the time and commitment and people have different views of work by balance. So you have some idea of what you're getting into before you actually make a decision. Standing out for the crowd, a classic explanation of how to get jobs. Having someone tell you that you need to stay out from the crowd is like me telling you the secret for investment success. So if you listen carefully the secrets will be told or I will now sell high. Great I'm done, if that's all you learn you have nothing [unintelligible] The idea is that I give you ideas you can actually implement on your first day after the class to stand out from the crowd and also having worked in multiple roles in multiple companies in multiple continents, I can give you an idea what managers look for because we don't work independently, we work as teams. When we’re on campus recruiting teams or what have you it's generally a group consensus and we'll go over what I call the mechanics and strategies for networking, resumes, cover letters, all the tools of the trade.

8. 2. Investment Banking

9. Investment Banking I

10. Investment Banking I So, the very famous investment banking and as I mentioned before a lot of it is terminology. Getting familiar with that and all terminology is confusing and somewhat conflicting almost. So first of all I'll talk about is when people talk about investment banking they usually mean the investment banking function the division. So an investment bank owns several functional divisions, investment banking, asset management, sales and trading and research and control some place. So investment banking is described as advisory, so all-- a lot of the movies will talk about being an investment banker is actually advising business. They're broken down by products and get into more detail later, at a high-level overview. They’re product groups and industry groups. So you become an expert in an industry to be able to advise over that sector. The main ones consumer products, TMT, healthcare, retail you become an industry expert in order to advise your clients on whether it's a product side, corporate finance, M&A, doing IPOs.

11. Investment Banking I Asset management like before either institutional, high net worth or even just retail. Sales and trading usually broken down into equities, fixed income, commodities and derivatives and research. All these functions will have some research component to provide support for the businesses to support the clients and support trading investments for clients. So investment bank, a lot of times the entire organization but investment banking is just the advising functions, the corporate finance and the M&A. These are some of the important, the more well-known bulge bracket firms. After the last crisis in 2009 there’s been few of them after they emerged and eaten up by all companies, but these names should look familiar and there's a lot of middle market firms that have grown during the crisis. Specialty firms and I think people larger capital basis were able to figure out how to survive as well specialty shops. Boutiques, some of them around for quite a while, Lazard quite well-known, Jefferies and during the crisis, the guys that survive survives getting stronger. What's interesting is actually seen to grow and the market share increase over time of some of these boutiques. So from an industry point of view I think that a lot of these boutiques specialize and they get more personalized services for clients and they're becoming a more important part of the business over time. So how would these firms set up? Product wise, corporate finance, mergers and acquisitions, a lot of the tools that they use are the same and they've broken down by different focus.

12. Investment Banking I Now what to learn about is the tools that market participants use to talk about the value of companies, discounted cash flow modeling, comps. This is what is used to figure out the company's valuation partially. The example I use is that I choose on Facebook, they came out and said $100 billion company, right that’s what Mr. Zuckerberg want. They didn’t say 99, they didn’t say 101, magically it’s exactly $100 billion. So part of your job if you work for finance or capital markets teams. How do you rationalize that $100 billion that Mr. Zuckerberg wants. So this is the language you use to figure out what the cash flows can be discounted to get that level. See what the comps are, but part of what you do is you part of it is backing into that number because that's what Mr. Zuckerberg wants and he's the client, but using tools because that’s how we convey to investors the value. You can't just go and say,” Well Mark want’s this number. This is why you should pay.“ So there is buy-side of advisory and the sell-side advisory because there's always two sides to a trade. Someone's buying something and someone's selling something. There’s mirror function of each other. These are kind of broken down to five major steps about okay. Is this a good fit strategy-wise? Is this complimentary? What are you getting from a merger for example, in case you’re buying a company or buying a division. Are you increasing the product line? Are you increasing your customer base? Are you increasing your geographic coverage? What's the strategic reason for this transaction? Potential investors, you have to sit there and say what's the market for certain transactions and it's a function of what's in fashion and where valuations are because it varies based on economic cycle and varies based on industry trends. Due diligence stage, you make sure that first step is make sure there's no fraud yeah [unintelligible] doing.

13. Investment Banking I Number two they just try to see fit organizations because the famous cases of where organizations on paper look great, but in practice not that what implement at all and part of its culture just to be aware of. I think when Digital Equipment Corporation and Compaq or is it Compaq HP excuse me. One company was focused on communicating through email, the others do voicemail. So when they merged they almost never talk to each other because they had different ways of communicating. Something as basic as that. You have the negotiation stage and the integration stage. You know in a very high-level nutshell this is how transactions are done. So what are their different roles for people? What the hierarchy? Generally groups are run by managing directors and they are the ones that have relationships with the clients. Then you have a director where if you look at kind of the day to day management of the team, it's done by the directors and they do supervision for the analyst pool and associate pool and this just very broad-based line for each stage and the reality is that to get to managing director there also has to be a spot also, so sometimes being at director level maybe five years maybe eight years maybe ten years, sometimes never just depending on what the group you are with has for options. The investment banking side they talk about analyst pools and associate pools. So the good thing about that is oftentimes you can work on many different transactions at the same time so just get broad experience and I wouldn’t say that it’s changeable, but you know their skill set is much more a tactical based with regard to doing research and doing the modeling.

14. Investment Banking II

15. Investment Banking II So, what should you think about if you consider this business? It's true 80 hours a week andgreater. And investing banking is more structured hierarchical organization and we'll comparethat with sales with trading later. So when you’re saying it’s hierarchical it's comparedto other functions within the finance industry. Attention to detail isvery important because the client also is often CEO, so that makes thepresentation is paramount and it typically takes a bit longer for career progressionthan in a sales tradable in a markets business, takes a little longer to impact. The plusside is that you do become an industry expert, so what are you able-- what were the optionsafter if you choose to leave the business later? You can actually get positions at thetreasury department, as a CFO in the target industry sectors you worked for because bydefinition you are an industry expert, which is a bit different than if you are sales ortrading person or even investment management person because that's much those are muchmore transaction transactional. So during this course I've going to discuss the differentideas happening in the market because one of the things that we look for when hiringa tech said who is really interested in the industry and the best way to show theinterest is to talk about what's happening within the industry at avery particular point in time versus just saying oh I really love finance, reallywhat about finance do you like?

16. Investment Banking II What can you prove through your own actions thatyou have interest and what knowledge have you've got from that interest? So I wouldlike to see okay, what's kind of over the last several years interestingtopics in investment banking space that banker can talk about to their clients. What is taxevasion? Has anyone heard of that recently? Couple of famous ones, some of them are pharmaceuticalcompanies in Ireland. Some of those who are retail shops, so Tim Hortons is a famousdonut chain in Canada. It's much smaller than Burger King. So the idea is that if a largecompany in a high tax jurisdiction such as US purchase or merge with a smaller companyin a lower tax jurisdictions such as Canada and you say okay this joint company now withheadquarters in Canada, lower tax jurisdiction even though the majority of business becauseyou're larger is done in the US. So you pay lower taxes. Now of course, countries don’t like you to do this. So they're trying to set up rules to avoid that okay and it's anongoing discussion. It died down a little bit but there's still some of the stuff goingon very typical. Number two off-shore profit system.

17. Investment Banking II Last year there were $2 trillion ofUS companies with money that they have created profits for offshore that they keep offshorebecause once you patriot the money to US, you’re to pay taxin US, okay. Large company Apples always goes to trial for this, well why don’t you bringmoney back. So the government has tried multiple strategies to get companies to bring the moneyback, pay some taxes and potentially equally important is to create new jobs on the US.So they call that a tax holiday. If you one time offer you bring you bring your taxesback you pay it back in a lower rate. However, the evidence has shown over the last severalyears whenever there’re these tax holidays good percentage of companies actually bringtheir money back on just as to stock repurchases to boost the stock price and not actuallyinvesting in the company either in technology nor hiring. So the purpose of thetax holidays have not yet been fulfilled, at least from the governments point of viewabout growing the economy okay. It’s just been about often times just been about increasing shareholder value. Other things we talked about is people taking about being analyticalbeing quantitative. Example of being able to show that you have some additional knowledgeof little above and beyond what you learnt in schools, I think it's always very helpfulwhen you get in discussions about companies. I like to look at pension fund liabilitiesas an example.

18. Investment Banking II So if you look at recent news there is one article late last year that saidunfunded pension liabilities for public pension fund in the US whichmeans public sector workers is equal to the GDP of Germany, kind of a big numbergiven Germany's large economy in Europe, that doesn't include all the private pension fundshortages, that’s probably underestimated. Why is it an underestimate? Look at what thepension liability number consists of okay. These are as I described many levers to managethis number okay, and beside these numbers. You can sit there and say okay if this tosimplify it, let's say I owe a $100 in 30 years okay. I can sit here and say okay Ihave $8 today and assuming whatever compounding rate I get in future value to 100 it's considered100% funded. Number one, how realistic is your reinvestment assumption? Okay. If I’m overly aggressive, what does that mean? It means I can put away less today contribute lessto get that that same liability number of a hundred and by contributing less it meansthat my earning is increasing because I had to put less away for the pension liabilityand stock price goes up, I'm a hero just by changing that one number. So the questionbecomes if I'm sitting here saying you know the depthof the crisis 2009-2010 I still have a resumption rate for next 20 years of 10%. Is that realistic? Let's break down of the pension fund between equity and fixed income products. Does that is that a realistic number? Sometimes it is sometimes it’s not.

19. Investment Banking II Alright, discountrate, lower salary growth because this is actual-- actuarialexercise. I'm going to assume that my final target I'm saying 100 assumes raises of halfa percent a years for the next 20 years. Is thatrealistic? So there are a lot of levers to control this number. So there's morelatitude if you look at a balance sheet, I always look at the unfunded pension liabilitiesas I look more carefully at the underlying assumptions for that. Now to be fair overtime the move has been for companies to go from defined benefit to defined contribution401k is for example. So now the burden of reinvestment risk has been moved to the employee versus being borne by the company. You can actually argue bothsides because that make sense because if I am a plumbing company a large company plumbingcompany, what makes me an expert about investing. Imagine if your company goesout of business because your investment for pension funds is wrong even though you havegreat plumbing plan. A lot of these companies actually use the same pension managers asfor their 401k plan, the Fidelities of the world or what have you. So it’s not as blackand white and say okay that it should be the company that bears the risk vs people, dependson what side of the political spectrum you're on.

20. Investment Banking III

21. Investment Banking III Mergers and acquisitions. What happens? Typically, the buyer company price decreases, the targetcompany being acquired price increases. It generally have to overpay incentivize peopleto sell the company at above limit, but there are exceptions to every rule. The latest onewhen Amazon bought Whole Foods. They both went up. So it seems as if you created valuefrom nothing and one of the reasons that you look at when you're over paying income statement what happens it’s added to goodwill that premium which over time creates future impairmentsbecause over time it'll go away. Talking about IPOs in the advisory side, the first thingwe talked about is there’s more than one type, there's two types of IPOs. Organic IPOsare the one most people are familiar with. Small start-ups gets really big, they go publiceveryone’s happy. Now there are certain IPOs that are based off investments for privateequity firms, public firms they get taken private by the PE firm, well what's the exitstrategy for PE firm? It could be selling someone else okay. Oftentimes other PE firms that focus on different stages of companies or it can begoing public again. Realize that there's a difference in the buying base ofthe different types of IPOs. Usually for the latter where there’s an exit strategyfor a PE firm you can have a higher debt ratio of acompany because you took a private company private the they incurred a lot of debt todo that and usually what you'll see is companies that are re-entering public markets from PE firms have no debt and slightly different buyer basis for the two of them. Some overlapbut there are some people that are focused on one way to the other, lay different stories.Another popular term people talk about is public side versus private side.

22. Investment Banking III The famous Chinese wall. I've never found a good explanation of why they call it the Chinese Wall. My theoryis that the Great Wall of China big wall, well-known let's usethat as an impenetrable wall. It just means private transactions versus what’s availableto the public. So we talk about insider trading is that when people on this side get informationthat is non-public. So who talks on the private side? Corporate finance departments talk to their clients. There's an upcoming merger talk, if there’san investiture or there's something about how to from a corporate finance point of viewhow to structure the company, that can possibly affect the stock pricethat's on the private side. An entire door is to make sure that no one gets informationthat either the bank for their own trading or for their clients, the information shouldnot be passed on to them. So when you work in a privateinvestment bank, there are very strong rules about exactly who have access to what information. I ran a team which had an advisory function. I couldn't know what people in parts of my groups we're doing because I stayed on the public side of thebusiness and I have kind of part of my group to work in the private side and allI can do is look at gross numbers for how they do from a business point ofview but I could not see what was happening within the relationship withthe client even though they work for me. Most research will be on the public side becauseyour providing research for investors as a service. So by definition it's going to beon public side. Then equity capital markets. So the idea is that here’s a specialized group that works with the private side when you're preparing the company to go publicor you issuing new bonds.

23. Investment Banking III You have to control the information, so that everyonehas access to the same information at the same time before you either debt issuance or an equity issuance. So it really isthe kind of information between a private sideof a bank and a public side because you have a lot of information to yourselfand trading people and research people to make it successfuloffering. So they actually sit on the they sit on the wall. So other terms that peopletalk about is front office, middle office, back office. What are these different functions? I described front office whether it's in corporate finance or sales and trading or people thatare directly client facing. So I think that's the 30,000 feet that's the best way to describethat and these are the functions that do that. Corporate finance, talking toclients, sales and trading syndicate. Research people go out talk to clients. Often times clients want to hear directly from the researcher versusthrough the salesperson about what the views are. Then you talk about middle office and back office. So middle office, risk management trades support and I woulddescribe back office is verifications that trap thattransactions happen correctly. So for example if you’re doing a rate setting for LIBOR,the determination will come from middle office okay, because they can do calculations andback office just verifies that it is implemented correctly and thepayments are done, so much more transactional. So that's kind of the difference. What happens a lot of times middle office people try tomove to front office, it's possible but it's cha llenging because I think oftentimespeople just view someone of certain role and [unintelligible] for so they kind of see thembranch out from that and if you look at schools and companies, certain companies go to differentschools with different roles and that's just the reality. They might go to some schools for their investment banking program and for trading progr am they might go to other schoolsfor for middle office and back office and IT.

24. Investment Banking IV

25. Investment Banking IV Moving on to sales and trading. As I mentioned earlier a lot of thebusiness is just jargon. So when you talked aboutfixed income business they can call it FICC, they can call FIRC. A lot of time terms goback and forth about fixed income as credit trading, government bond trading, currencytrading commodities, interest rates, it's banks get no companies in general get reorganizedall the time to try to improve efficiencies. A lot of time to go back to what you started,you know 10-15 years ago, but just when you talk about fixed income it could be describedthe division as a FICC or FIRC or what have you. It generally begins with fi that's thepredominant part of the business or if you notice since the peak of the crisis is thatfixed income revenue is half of what it used to be. Now several reasons, the big reasonis that by definition if the bubble bursts there's less stuff. The pie is smaller okay,because what created the bubble was kind of artificial and now it’s kind of resort backto normal again, but also the world has become more plain vanilla with lot of type of products.The less complicated products, so the less complicated the more commoditized and at thevery least there will be lower margin products. It's become more of a flow world and that'sstill kind of continuing. People will say,” Well, cycles come and go.“ Well yes, butmy viewpoint is that what is the most valuable asset the typical Americanhas. What do you think? Their home more often than not. We've already leveraged that withthe subprime crisis. Anything else we try toleverage we’re likely to be smaller than the most valuable asset.

26. Investment Banking IV People talk about the student loan price coming up it's 1.5 trillion still less than the housing market. So even though there will be cycles and we'll come back probably notas large as it was before because it was a perfect alignment of stars between theasset class, the rating agencies, the buying base, combination of the law, I think was the perfect storm for the 2009 crisis, but $100 billion still a pretty good industry to get into [unintelligible] be scared off from that. So what are some of the differentproducts, sales and trading, currency products, spot trading, option forwards. What drives currencies a lot of macroeconomics reasons for that. So this is the stuff you learn inmacroeconomics. Now for having a job in that space a lot of it is technical analysis. What are the flows because that's important. The basic understanding of supply and demand can get you a long way. So if you sit there and say okay where is where this is business going. If if the US is buying products from China because this is the factory of the world and China is buying natural resources from Africa and South America, you get a very broad understanding of what money flows are and that drives currencies as well as the interest rates within countries itself. So this is kind of where macroeconomics does matter for currencies and interest rates. So fairly it’s kind of technical, more sothan straight equity for example. So if that's kind of the view you like to look at thenthis would be something that you’re interested. Now over time with technologies it's harderto make money from trading okay.

27. Investment Banking IV If you go back let's say 30 years you can do two crosses,across three currencies and make a perpetual arbitrage. Now it's at least five or morecurrencies because the world is much more efficient efficient and there’s fewer arbitrages opportunities because the velocity of money is much quicker, and information is a lot faster. Commodities, there’s hard commodities, usually precious metals like gold. Again,technical analysis you just sit there and have a view on industry demand as well astechnical analysis to see where prices could be. Fixed income products, so that's kindof the generally the largest groups or in a fixed income world. Government bonds have like a little bond math and again government bond because it’s based on government policies.Now we get back into the macroeconomic world of the price flow or trade. What interestrates are at a macro level of the country. How does that compare to interest rates inother countries in addition to the current account deficits? So you go from a high-level macro to all of a sudden you go to corporate credit which is now looking at specific companiesyou care about you care about what's happening in the industry, and thesector, but you're focusing on company. So broadly speaking it’s investment grade or high yield which used to be called junk bonds.That is your first-- Junk mail junk bond sounds so negative it’s junk, so they rebrandedit high-yield after the debacle in the 80s. A lot of whatfinance is rebranding old stuff to sound more innocuous after something melted down. We'll talk about this later. Emerging markets used to be insultingly LDCs less developed countries okay and that wasn't that far back, so we justrepackage things. Now you can have financial statements and analysis in accounting.

28. Investment Banking IV They really dig through numbers to figure out okay is this credit worthy or not. Municipal bonds are anything state level, city level, municipality. It comes in two flavors, a general obligationbond we call the GOs or revenue bonds. So for exampleif you buy US Treasury it's backed by a full-powered faith of the US government effectively to collect taxes okay. Your bond might be paid back from any specificstream of income. So if I’m New York City I can justsay okay it's backed by the full taxing power of New York City, but you can have revenue bonds. So that bond is based only on specific projects for example MTAfor tolls. Your US excuse me New York initial bond just based on the toll revenues for bridgesand that's the only place that you can get repaid your interest as well as principal.Tolls for roads, these are the most popular revenue bonds. Now over time they go in and out ofvault. Sometimes they say GOs better revenue, sometimes revenues better. Now we're backto GOs again. So you think you kind of see what that is. Project finance, they just rebuiltthe Tappan Zee Bridge up in Hudson Valley. They finance that with bonds. So the areasif it’s in top emerging markets as we mentioned and we like have cute names for some reasonUS markets has the cutest names. They have BRIC which is Brazil, Russia, India and China.Then they expanded that that to BRICS, they threw in South Africa, so it became BRICS.Tiger Cubs, Tiger is Korea, Hong Kong, Singapore. Then the ones that are not as developed inSoutheast Asia, you have Malaysia, Philippines, Vietnam, they called the Cubs because they’renot full tigers yet okay. The challenge here is that besides just looking at governmentand corporate issuer you know corporate issuers are there are high level of political andeconomic risk and instability. That's just kind of a nature, so there’s additionaldimension, but then on the other hand the expectation is because there's more volatilitypotentially higher growth.

29. Investment Banking IV So depends on what you enjoy looking at. What your risk appetiteis? This entire group of area under fixed income called structured finance. We talkedabout ABS, mortgage-backed securities, collateralized loan obligation, CDOs, collateralized debtobligations. These are very documentation intensive because they often set up SPVs asstandalone companies. You put assets into them and you slice and dice the cashflows for different investors with different risk appetites, very modelling intensivebecause each of these separate tranches have to be rated. These are generally private placements.These are not listed on the exchanges. So what are some of the basic career considerations?Because the market focused you get a lot of early morning meetings to get there beforethe clients, get into the office to prepare the news with the latest research and eventsfor your clients. So you get government traders get in by seven, corporate guys a little bitlater. At the tail end of the day there’s a lot of-- sales trading is lot of winingand dining for clients. So you have to get it early and you have to work late, slightlydifferent than investment banking, but hour wise it’s still less. Now interest rateproducts, here people you know your clients in interest rate world or both financial clientsfor trading and investments as well as corporate clients because if I want to let's say I’mIBM, I want to issue a bond. That issue is fixed or actually it’s floating? Is thatissued for three years or 10 years? All these considerations are all of the corporate treasurydoes is finance companies. So you just sit there and say okay what's the swap marketdoing? Should I should I swap, you know should I manage my asset liability for a companyusing interest rate derivative products, such as swaps. As a derivative product, generallywe talk about modeling as well as more quantitative views of the world. So interest rate productsis what caused only the original derivative debacles [unintelligible] every investmentsin interest rate products.

30. Investment Banking V

31. Investment Banking V Equity stocks it can be broken down into the cash desks for people to who we know asinvestors, retail investors, who buy stocks who buys indices, buy baskets. Derivativesof those cash products those buying stock options, futures, total return swaps and what’s relatively new are exchange-traded funds. So an exchange-traded fund sounds like a mutual fund. You got a basket of stocks generally market weighted so it gets less diversity, but there are some very big differences in the tax treatment of ETFs, so one of the mainreasons that people like ETF is that when you buy and sell a mutual fund you can only buy and sell at the close of the day. You cannot trade it the way atrade stock. So there’s no intraday trading. ETFs you can look at it as collection of bonds excuse mestocks or bonds, but they can be traded throughout the day as it was a mutualfund or as a stock. You can have funds at the long positions only. You can have positionsthat are actually short positions. I can buy ETFs that makes money when it goes down insteadof going up. You have ETFs which are leveraged, you get three times the return double return,but it cuts both ways. There are also tax implications other that in certain ways exchangetraded funds are more tax efficient. So I now compare an ETF to mutual fund okay. Theday before I purchased a mutual fund, they had a 100 shares of IBM, it went up a lot.I buy that mutual fund, the second day I own it. The fund manager sells the 100 sharesof IBM and there’s a big capital gain because I’m the owner on record now. I’m responsiblefor paying taxes on that capital gain even though I bought it a day before they soldit. This doesn’t seem fair, does it? That’s the way mutual funds work okay. The term is called phantom tax like a ghost because hold it I never got the gains for it.

32. Investment Banking V If someone has sold their mutual fund shares the day before they sold the stock, they didn’tpay tax on that, okay. The poor guy that bought it the next day that didn’t get depreciationbecause the mutual fund price went up with the shares, right. So imagine a superfetation case that the only the mutual fund owned was IBM shares. So it went from $1 to $50 okaymore than the budget was, so what happens is that that one share the mutual fund ifit was one share, you pay capital gains on the value of the mutual funds, that’s okaythat’s kind of fair because you’re selling those mutual fund. The next guy that buys afterwards this guy looses out because that’s when the actual tax penalties occurred. ETF doesn’t have that problem because it’s based on the value of the fund itself notthe underlying stock price excuse me not the underlying tax liability. So under equity products in terms of trading is a prime brokerage. So people with prime brokerage what that reallymeans it private banking services for institutional investors. They make loans, they provide stocks on margin for hedge fund for example and PE firms as well as family offices, institutionalinvestors really. So what should you consider about life in the equity world? The differencebetween fixed income and equities very broadly speaking is that in equity world you’reselling the story with some potential. There are obviously numbers behind that, but equitypeople invest in equity for upside. They have to believe in the story that there’s goingto be reasonable increase. When you invest in a bond, you have no upside okay. You justwant to make sure that your interest and principals repaid back over the time frame it was promised.So all you have is downside is not being repaid. So if you look at it that way broadly speaking,the fixed income people, the credit people are more cautious because I have no upside,I will have downsides, I’m just focused on downside.

33. Investment Banking V Equity person, yet you have tobe able to believe and tell a good story about why there is growth potential. You also haveto be kind of be aware of what’s happening in markets, in indices, you have to talk aboutthat everyday, which is kind of why you watch all the news channels, all the financial channels,there all got indices all day all day long. To me most of the daily changes is noise,but this okay I have to talk about. One other thing that people use to measure is what’sthe PE ratio. Price of the stock to its earnings. That’s also two types, one is the trailing PE and ones a forward PE. Trailing is historical okay. What is the price divided by earnings over the last year quarters and forward which is actually what’s been projected. The vast majority of people talk about trailing PE because it’s something that you can actually see versus what you can forecast and besides looking at stock price to see what the volatilityis, either looking what’s the volatility of the PE, by definition if the PE ratio isvery high, it’ kind of expensive. That’s what people are willing to pay for those sameearnings. So what people look for is okay, so the PE what range is the PE trading at,so not just the price, but the value. Are you willing to pay more or less for thosesame units? You also have a view, when talking to someone in the equity world and you say,”Hey, I love the market.“ Really? What’s your favorite stock? What’s your least favoritestock, why? What’s your view on a sector, why? They want to figure out the thought process. Did you just watch the ‘The Wolf of Wall Street’ and realized I want to be a stockbroker or do you actually have some real interest. They want to see that more than just a superficialinterest that why I mean I want to make a lot of money because I read the book or sawthe movie big Jordan ‘The Wolf of Wall Street’ and how do you show your thought process?

34. Investment Banking V Well, view about okay this product or service will be increasing or decreasing based on,is it demographics? Is it some change in different trends to consumer trends? Is it some financialtrends that is going on that would effect whether the stock do well or not. We will also talk about okay what kind of detail can you explain your view. The more the detail the more convincing. The better story you got, and they want to see are you able toput together an analytical argument for your view, what will change your view, that thenext step. Okay these are my views. What can you see potentially how can that make you change your view. That means you’re open minded. So this kind of looks like explodingspaghetti factor, right. The idea is to show that even though you may be a sales personor a structuring person or a trader you interact with a lot of different other functions inthe organization, okay. So I just made the difference between solid lines and dottedlines, say how direct or how often communications are. The classic one is client talks to salesperson to see what the trading price of something is, which makes sense. We’re going to buyit or sell something. A trading has to deal with risk management because risk managementmakes sure that they don’t want trading to both of them. For example, there’s aconcept of if I’m trading for clients I shouldn’t have too much inventory too muchrisk in case you know inventory get old and gets staled just they way you know productsare in retail. So the way they manage that is the older your position is the more capitalthey put against it because it’s more risk, which means your return on capital for sellingone stock decreases over time. So the older the inventory the less profitable used tobe the key. So that’s one of the one of the levels that they use to help risk managementfor the bank. You can’t just sit on it over time hoping someone will buy it at your price.

35. Investment Banking V Research supports trading and structuring ideas. We talked about legal, get clientson board with those KYC know your clients. I’ve talked legal, talked of compliance.Structuring thoughts to probably the most important because they have to get informationfrom the client obviously. What’s the pricing? What structure are interesting and doableand because it’s not a floor product they had to do more compliances to say, is thissuitable complicated product for the client. Are they the right level of sophisticationor not? And depending of the structure there might be some residual risk the bank musthold, if you talk to risk management also. I mean the goal is to structure somethingwhere the bank just intermediary and holds no risk at all, but sometimes there are somebasic risk, sometimes there are some risk [unintelligible] hedge otherwise dynamicallyand is something that we could work with trading in risk management, if it’s not a complete[unintelligible] because if you’re getting some risk then you get some reward for it. The goals could drop or it could be sufficiently paying for that risk that we’re taking. Repose again is a funding function. So for example if I’m buying a car the absoluteprice will not be the only factor. If I can get cheaper financing for that car even thoughthe price maybe more expensive, but my net payments were cheaper I’ll go for the moreexpensive car with a lower interest rate right, the same thing. A lot of times the clients who buys stock and repos desk will give you some rate that they can actually borrow that,so the overall net price could be cheaper because you have a cheaper cost of fundingfor the bank than just the stock price. So when I mentioned earlierin investment banking is more of a hierarchical structure and down to the director down tosort of an analyst. Here it’s much more flat organization, but amongst that flat organizationyou’re talking to lot more different functions till the trade is done. So it’s a littlemore chaotic, a little less structured.

36. Investment Banking VI

37. Investment Banking VI So we talked about trading a little bit, now we just talk about actual sales functions.So you can talk to broadly speaking two classes of clients, financial clients or corporateclients and generally, organizations are broken down to different coverage because slightly different skill sets, slightly different knowledge basically of day to day. So corporate clients like okay even something if you’re electronics company and you buy gold because that's oneof the one of the commodity that you used to build circuit boards, then should you hedgethe cost of gold because you build electronics you know cost of goods you get to be withthe market, why you want to hedge that? And then you know traders and portfolio managersthey want to invest having a directional view. Sales person part of their job is to dealwith compliance, negotiate credit lines with risk management also and ISDAs, which is thecontracts for International Swaps and Derivatives Association. So when you enter into a derivativeyou have contract that say okay, this is kind of this is kind of what the terms are foryour transactions. So as a sales person I describe sales a natural acts for people as most peopleus be social creatures we like confirmation, rejections are bad thing because who likesto be rejected? Successful sales people don't view that the same way. It's not a rejection, it's a numbers game. If you're able to get that mindset it's not a personal rejection,this is business and you played a number of games, right. You’ll do well and the moreefficient you do it, becoming better at it and just get a higher hit ratio. Think aboutbaseball, if you're battling 333 that mean two thirds of times you're out. You'll neversucceed one out of three times, you’ll say that’s some kind of bad thing, get rejectedtwo third of the time, but all you need to bat to bat 300 350 then you’re considereda superstar even says and the other thing also is okay you work for the company, theyknow that you're trying to make a profit and generally don't begrudge you for that, theywant you to be kind of honest with regard to what you're selling to them.

38. Investment Banking VI So you’rereally balancing the needs of the clients and the firm. You can't give away to shop.You know they can’t continues loss to get a happy client and unhappy boss because you'renot making money. The lights have to be paid for. Your bonus has to be paidfor. There's always a balance and that oftentimes requires the ability to sayno to the client okay. You can’t always say no or you’ll get no business, but thisis kind of managing the relationship of that balance.So basic supply and demand as a salesperson isable to explain that as a trader kind of see what the trends are. So I’ll use gold asexample. There's a consumer demand for gold jewellery, biggest one actually India of thecountries. There’s industrial use for gold for electronics. There’s a financial purposefor gold for people in times of stress, people move money to gold because they think it maintainswealth while all the stock markets are crashing [unintelligible] so they'redifferent things as a trader or economist you have to figure out a kindof these three or more factors which one's dominating to what degree, you figureout if golds going up or down. There’s even for financial purposes if you’re a goldminer whether you choose to hedge your production and your sales of the gold or not can affecta gold price because what happens is that okay if I'm a gold mining company I have somefixed costs. I want to make sure that if gold goes too low if gold price goes too low Ican't cover those fixed costs. I'll go out ofbusiness. So I make future sell the goal at certain price just to make sure I lock ina price. So whether I choose the hedge or not affects a supply and demanddynamic because I'm going to hedge these prices, you can hedge it with a bank. The bank has to go into the market potentially to trade gold to hedge the hedge[unintelligible] and that’s dynamic hedging banks can make or lose money doing that butjust one more flow to be aware of. Same happen with oil. If you think that the if you’regoing to buy stock in BP for example or Exxon, is that really an investment in the priceof crude oil depends how much of production is hedged. If it’s all hedged then theyhave zero exposure, gives more exposure to bank than anything else.

39. Investment Banking VI You look at equity derivatives, stock options. What’s the supply demand for that? For the financial investorsit could be biggest one leverage biggest one leverage return, but there’re a naturalpeople I want to sell. If I'm working at Google for example and I get a lot of stock optionsas a manager. I may want to hedge that because. Do I want to double down? Do I want my jobat Google and my investments at Google, so if Google goes bad they laid me off and mystock price will decrease. Do I want to double down or not. So a lot of people would justwant to diversify their hedges, so it’s not to sellin response. There are certain sectors that are more prone to supply and demand factors.For example, one of the structured products I mentionedearlier was a collateralized loan obligations. So the idea that adiversified portfolio across multiple industries and multiple issuers todecrease the correlation risk, but gaming was popular because to put into thesestructures because it adds diversification, but there aren’t a lotof gaming companies that had that, so itdrove the price up because it was high demand to add diversity to these structured products.So once again one of the very basic tenets of economics is supply and demand,but understanding that at tactical levels of work.

40. Investment Banking VII

41. Investment Banking VII Trading, the sexy job of trading. So broadly speaking two ti mes of trading—two typesof trading. There’re market making for clients where your focus is on just having buyingand selling for clients or for proprietary trading which means you're actually committingthe bank's capital to work okay. So you’re not trading for clients you're trying to makemoney for the bank by taking directional positions versus just facilitating bid/ask for clients.So looking at the price there’s a fundamental or intrinsic value for any kind of financialasset, so for stock it's okay basically when it bleeds growth ends, your earnings, allyour wealth, there’s some value. However, there’s also a supply and demandaspect of any stock. If there's very little trading the prices wouldn’t mean as such.There's also technical factors if if the stock is in the S&P 500 and I'm a mutualfund or I'm an index fund and I'm saying it’s okay well I’m tracking againstthe S&P index, the price is going to increase when something gets added because there'sa demand to be bought for all these funds because they're tracking a certain index. The same goes the other way if some company drops IV index the price will decrease andpeople start selling that stock if they don’t need it anymore in their portfolio to tracean index. So these are again more technical factor for supply and demand which affectthe stock prices. And when you’re sitting here and say okay I’m a trader for retail firm and I want to make sure that my portfolio during the days is kind of it’s kind offlat. I don’t want to carry a lot of overnight risk. That’s individual stocks. I may actuallyhedge some of that with some sector with ETF. I can hedge that with some of baskets of productswhat have you, but there’s basic risk because there’s different dynamics for people tobuy baskets than individual stocks. So yes it can be stressful. It’s a matter of havingviews okay and being able to convince your manager, convince risk management, convinceclients why your views makes sense. There’s technical trading also. You can actually explainall these moving averages, all the particular trading, there’s support levels. So it’skind of language in itself.

42. Investment Banking VII You might figure out okay at any single point in time whateffects that makes, the fundamentals or technical factors. And oftentimes you get you know no,sometimes you get conflicting data, two different markets will tell you two very opposite things.What resource to believe? I use the example of Enron when I was in a company, so stockprices going up, great story, people love this stuff. At the exact same time so creditdefault swaps just think of it as bond spreads okay. The wider the bond spreads then there’sjust more risk. I need to be compensated more because there’s just higher risk. The same time the stock price of Enron is going up, it’s credit spreads were widening. Hereis the bullish indicator for the stock market and here is the bearish indicator for thebond market. Whom do I believe? What’s going on? Trying to figure that out and what peoplehave realized from the 2009 crisis is that debt market is more of a leading indicatorthan the stock market. You can argue why that is. My personal view is that okay, if allI have is downside I don’t have to know I don’t have to be convinced that there’ssomething bad going on. If I don’t if I don’t understand why something is goingwell then there is risk, uncertainty risk. So what happened during this time because I was actually trading in this market, watching this stuff, like people were saying okay wellwe can’t exactly point to what’s wrong with Enron, but the numbers sound too good.That sounds risky credit spread widen. Now obviously the reality is that they defaulted. They were fraud all above, but and even 2009 people began to see that the debt market ismore of a leading indication compared to [unintelligible] and what’s also confusion, even stock pricesthat peak before earning and the stock goes down. Why? For years it was kind of a whispered numbers. The analyst put up real numbers, but they had whispered numbers beat the whisperednumbers or not. Asymmetric information in the markets.

43. Investment Banking VIII

44. Investment Banking VIII Securitized products, this is kind of where my backgrounds a little bit more. This iseffectively any non-flow product besides a straight stock or bond or interest rate [unintelligible] So we talked about asset backed securities and asset backed commercial paper which tothink of is just the the tenor or the maturity investment. Commercial paper overnight 30days give or take and what could he put into these securitized products? Anything you canpossibly think of, again the biggest asset class you know the mortgages, residentialmortgages, commercial mortgages, home, equity, loans, home equity, lines of credit, bonds,loans, consumer credit, credit card loan, auto loans, card receivable, anything thathas some kind of a payoff on regular basis, they can securitize that. What’s the purposeof securitization? The purpose of securitization is a distribution technique to sit there andsay I'm going to create different securities out of the same pool such that provide differentrisk return ratios for different investment types. All the world is broken into assetsand liabilities. Assets is the pool of products I mentioned before which produces income whetherit’s the loans for student loan. Whether it’s mortgages tobacco sort of payment. Anything I recruit that's the asset. What are the liabilities? The liabilities are thedebt that issued to pay for these assets. So this is just the basic loan portfolio andgenerally what is called two waterfalls. When interest is being paid from the assets, it'sused to pay interest on liabilities and when principal is paid back then is used to paydown the liabilities or if it's a reinvestment period, if one bond matures it's allowed tobuy new bond to replace that, so the the structure doesn't amortize during its investment periodto maximize the return for clients. So how does this generally work? If things go well,you want to pay interest to most senior person, junior person and I think it goes to its debits.If things don't go well, if all of sudden the performance is not asstrong, they going to withhold payment to the equity person and pay-- use thatmoney to pay down the principal of senior debt to deleverage the structureto keep it safe okay. So this gets done at every level.

45. Investment Banking VIII There's an interest coveragetest, there's an overage cut coverage test. Sothe entire purposes of the securitization. Howsenior debt junior debt any mezzanine debt, all that is leveraged for the equity. So theequity person generally wants as much leverage as impossible as cheap as possible. So theirgoal is to get to senior debt as wide as possiblebecause it's the cheapest debt and he want the most junior debt as small aspossible because this is the most expensive debt. So that's the entire game. How do youknow or what are the strategies to do that okay? Part of that is diversification of theportfolio in the asset side. So the more diverse and the more granular the less they're correlatedwhich means that there's less risk which means that I can afford more senior debt, okay.At high level all securitizations is same that way in trying to minimize the fundingcost for the equity. Along the way there are ways that you can manage the size of thisdebt by excess spread trapping instead of paying things out, you create a definitionof buffer for safety for dealing with that guy before and for the equity people and you'repaying down debt or you’re paying down all the seniors debt first, the way to structure isor you pay down some senior debt and some junior debt. So all those modelling isbased on what the asset profile looks like. What does the default stress scenarios thatthe rating agencies could go through is what all the modeling to figure okay what's themost efficient structure I can get. This is securitization. This is the modeling for thatand usually the bank's analyst and structuring people create these models in conjunctionthe past test that have set up and criteria that are set up by therating agencies because oftentimes investors are constrained about theratings of assets they can buy. So broadly speaking, the structurer role is tocreate something which fits the market view and risk return profile of clients. A lot of structures and ideas that we propose is based on historical data andsay that if you had a product structured this way and this market scenariohappens you get this type of return. In another market scenario happens this kind of terms—infact this constant [unintelligible] products to clients goes to term profile, something called the principal protected note is a way toget exposure to a particular asset class but then still have a safety on yourprincipal.

46. Investment Banking VIII So a lot of modeling a lot of structuring includes derivative productsis a more efficient way to gain access to win asset class tending to be verydocumentation intensive because you’re creating a SVP that only job is toissue different tranches. So you’ve lot ofpaperwork to each liability class will be a differentdocument and transactions can have besides the economic outcome based on thepayments of interest principals. You have taxconsequence and accounting consequence and aregulatory consequence, okay. Be able to create a single instrument that could be for exampledebt for accounting purposes but equity for tax purposes, the same instrument becausethey they have different worlds, so they look at it differently. Sothere might be some advantages for creating something that is debt for one purpose andequity for another purpose, if it fills the need. I need a regulatory for example if you'rea bank and they want to have equity as a buffer in case if is wasn’t the bank, so that thebank doesn't go out of business and destabilize the banking industry, but equity is the mostexpensive way to finance something because the return is slightly high. So they createhybrid securities that look like debt and equity or equity depending on situation andregulators have come down hard against that because they say you know you have to makesure that the equity is there—there is enough capital for the bank before it goes insolvent.So a lot used to do is create hybrid securities. So when you say hybrid you mean in some waysit looks like debt and in some way it looks like equity. So Ilike to just kind of get into a couple trade I liked over the years because it givesyou a view on what's possible. It's not and to be safe most of these deals have allmatured and lot of them you can't do anymore because of a differentregulatory environment, but I think it's important to kind of see the breadth of type of structures that have actually has done and what I personally findinteresting. So this is what is a tax efficient funding structure, okay. So Bermudais a zero-tax jurisdiction. So the first question is, how do you have a tax efficientstructure for a company in the jurisdiction that pays no taxes? So thisis what they did. You have a single A investment grade rated insurance insurance company inBermuda, pays no taxes. That same insurance company have a single B rated high-yield subsidiariesin the US.

47. Investment Banking VIII So what we did is okay have this high-yield subsidiary issue high-yield debt,okay. Now by issuing in detb all the coupon interest payments that are paid is tax-deductiblein the US as an expense for the company. So because it is high-yield is going to be abig coupon, you get a big tax reduction. The bank set up a ABCP conduit we would buy allthe bonds issued by the subsidiary okay. So single investor, so the coupons that the highcoupons are paid from the debt that is created gets paid tothe bank. So we have nice income okay. But ifthat's all we did that means we're just buying high-yield debt, which is kind of risky fora bank. So what we did is okay we're going to buy credit default swap protection on thesubsidiary from the parent company which is single A. So effectively the parent guaranteesthe debt of the subsidiary. So the exposure now is a similar way. So we pay some premiumto them, we have exposure to this insurance company. We can actually go up to market becausethere was CDS market for the parent, so occasionally we would hedge that. Why do all thiscircular tech logic? So we paid CDS protection to the parent based on the rating assumption. So what happened was that because it's Bermuda the companypays no taxes on the premium it receives as income. They get a tax deduction for thehigh yield that they issue, then that combination of income tax deduction is cheaper than ifthe single A Bermuda company went out into market and issue single A bonds. So againit's just a cheaper financing because they takeadvantage of the ability to deduct their high interest paymentscombined with the tax-free CDS premium they’re receiving. So that combination wascheaper than what they were able to sell bond and financing stuffs. No longer available because now the rules are that you cannot buy protection on a some of these parent. Once you understand the boxes are arrows of things then you understand money the cashflows, once you follow the money everything makes perfect sense. Soanother example of just kind of looking at at the structuring world but morebroadly, how financial hardest work is if products have the exact same payoff in theexact same situations then the price is the same. The question becomes well what are potentialdifferences? So I'm going to use this example. I'm looking at four different assets here.The first is that IBM itself as the company issues a floating rate note which pays LIBORLIBOR plus 150 basis points.

48. Investment Banking VIII The second product is an asset swap fixed income bond. So nowyou have a fixed income bond and an interest rate swap which swaps the fixed coupon intoLIBOR plus 150 again. So you get the same coupon 100 basis. The third structure is you’rea bank itself now that issues a credit link note, like the IBM. So Citibank says okayCitibank issues a credit link note based on the credit of IBM and we'll pay you a LIBORplus 150. The fourth structure instead of havingthe issuer be the bank. I set up a shell company and I don't understand okay shellcompany just means the sole purpose is for this transaction is not to showas if you’re hiding something, so we can move from the liability point all does isholding. So we set up a shell company SPV to issue a credit IBM credit linked note thatpays L plus 150. So let's say it’s the same amount. So $100 bonds five years and paysL plus 150, all the same. Should all these four different products be priced the samebecause you have the same, you have you have exposure to IBM same amount of time. On surface maybe but just think a little deeper. Look at risk, the idea is to figure out what areall the possible scenarios that can happen and what are the pay-outs in each of thosedifferent scenarios. So we've mentioned everything references IBM at some stage. So let's sayIBM doesn't default, five years L plus 150, I'm a happy person. IBM doesn’t defaulthere okay and the bank why is it a fixed income bond. The bonds that performs the fixed interestrate coupon gets swapped the floating L plus 150, I’m a happy person. IBM doesn’t default. However, then all of a sudden let’s say Citibank provides the interest rate swap okay. Citibank takes the IBM fixed-rate bond and gives you the L plus 150, but if IBM doesn’tdefault, but Citibank defaults, what are you left with? You’re not going to be paid Lplus 150 anymore because part of the transaction is gone. What you're left with is the mark-to-marketon the value of that interest rate swap because here all you have a bond. Here you have apackage of a bond plus the interest rate swap. The interest rate swap gets cancelled whenthe counterparty defaults. This interest rate swap might be it may be sold, terminated ata profit or loss you have no idea. It depends on where interest rates are at that time basedon when you entered the interest rate swap. So you could win you can lose. You may win you may lose, unsure.

49. Investment Banking VIII Here, let’s see Citibank again. They issue you credit linked note,so if Citibank doesn't default and IBM doesn’t default you get paid over five years. Yougot L plus 150, everyone’s happy. IBM doesn't default, Citibank defaults again, they didn'tbuy the bond as they did here. They ended into a credit default swap on IBM to get thatIBM corporate exposure instead of buying the bonds directly, they just did a credit defaultswap on IBM. So all of a sudden Citibank defaults, the IBM CDS goes away is a mark-to-market.It could be above, it can be gain or loss depending on where IBM spreads are, againuncertainty. Now because when when you have cash as an investor cash is used to purchasethe bond. Cash is used to purchase the bond. Here cashis used to pay for is paid for bank notional amount okay. So they’re using the money.Third one is an SPV shell company by definition is a shell, there’s nothing there. Whenthe money comes in they have to put that money to use because as we said before it was LIBORplus 150. So let's assume that 150 happens to be IBM credit spread. So that mean thebank was paying you to LIBOR part okay, and they got the IBM spread of 150 from the marketsomewhere on the other side. So they created a bond for you that paid L plus 150. Here’sone step forward, instead of giving the money to the bank to create the LIBOR part of thecoupon. They go out and they buy some kind of bond collateral which use credit card bondsfor short term or what have you, that pays LIBOR because it’s a triple A asset, pays LIBOR. So now this SPV has two transaction, it owns the bond which pays the LIBOR. Ithas a CDS that's paid 150 basic points, so it created a new debt instrument that paysLIBOR plus 150. Bank goes out of business the mark-to-market CDS again. That’s ones cenario. Bond collateral with triple A credit cards. Well, if the bond defaults all of asudden, okay what the market of bond? Probably less than a hundred, there's risk there. Sonow I risk to—I have risk to the bank Citibank. I’ve risked IBM and I’ve risked the bondcollateral. So one way we used to make money is that this did pay LIBOR. This played LIBORplus 10 basis points. So the bank in the structuring we just keep 10 basis points you paid LIBORplus 150, that’s what you got. That’s one of the ways bank make money. Now additionalrisk is this, I mentioned that this is a five-year transaction, it's almost impossible to findcollateral exactly returning the exact same day. So there's two ways there's two waysto deal with this. A, you can take a view because you have to take some view.

50. Investment Banking VIII Let’stake let’s say that this is a, this credit note is five years. I'm able to find collateralthat's four and a half years or five and a half years,neither of them are perfect fit. If I buy abond that's four and a half years, there’s sixmonth period for which I could pay just for that LIBOR part. I'm takingsome interest rate risk here. You can fix it you know you can hedge that alittle bit but there's some cost involved. That's one option, another optionlet's say I'm going to buy a bond that's five andhalf year. So I'm going to sell it when it's only six months left to that bondmaturity. What's it going to sell it? I don't know right now, again additional risk. Sothis is what structurer do, they sit here and say okay what are all different possiblescenarios there are? What all the different basis risk I have livewith? How can I hedge that and minimize that? So a very basic level when I interview peoplethat are I think are doing MBA [unintelligible] fixed income okay I will use this scenarioand say okay here are the different scenarios. Should there beprice different, if yes why and which prices should be higher or lower? Becauseof this is this is what real structures do. You just create all this credit notes createdfor institutional clients as well as we retail clients. I mean this doesn't get, it has somethingimportant for the client like, but this you’ve learned more than what 99% people on WallStreet don’t understand about, you know how derivatives are used in products.

51. Investment Banking IX

52. Investment Banking IX Moving on we said about funding, what do banks do? Banks provide funding. It’s a financecompany, but I want to explain that there are many differentmechanisms to provide funding for clients, loans and bonds are very simple. Commercialpaper, so repos used in the fixed income world, so repurchasing agreement. Take a bond andthen one asset and then a buyback at some interest rate, that’s financing. In equityworlds it’s called [unintelligible] securities lending. Then there’s prime brokerage whichis doing funding for hedge funds and ones you know you can do margin trading and evenwhen you have swap lines. When you entered your swap generally, it's a zero mark-to-market,but if the mark-to-market is positive to the bank it means it’s negative to the client.The bank has effectively lent the money because now you’ve created a credit exposure tothe counterparty. So if I did an interest rate swap with General Electric and the markto me is $100. If General Electric goes out of business, they still owe me a $100 becausethat interest rate swap terminates upon default of eitherparty but they still owe me money. So all of a sudden I’m over $100 by GE, I become generally an unsecured creditor as if I was unsecured bond holder. So this is notgoing to help fund clients because the bank is providing them credit lines,whether I give them a credit line for a $100, I give them loan from a $100 or I givethem swap lines for 100, I still owe the $100. That’s another funding mechanism. Securitizationis another way to help clients, here it’s more of a service and structuring functionto provide leverage to clients. So if you're a hedge fund or private equity fund and youwant asset—access to auto loan industry we cancreate a CLO where your equity and you get leverage returns on that assetclass, again another funding mechanism. So there all sorts of parts of a bank which providefunding. So it's not just simple as a loan. Here are some of the earliest slides, so somereturn that you may hear when you talk to somebody for funding is what's the collateral?What's the asset class? What am I lending on? Haircuts, what's the margin?

53. Investment Banking IX It’s justlike a mortgage. I don't give you a 100% loan value. If you're buying a $100 house I’mnot giving you a $100, I may give you $80, the risk would be that if you default on yourmortgage, if I buy a house at $80 the loan to value is 80%, if it goes down to 81% ofthe price that can still give me whole on my $80 loan. So that mean haircut, how muchwill I lend not against 100%, it’ll be some number less than that, okay and as the priceof unlike asset moves around, I may have a margin call because I want to make sure I protect it my position because I find answers for you. Breaching a $100 bond I lent moneyto you at 80, if the product went from $100 the price down to 90 I might ask you for another$5 because I want to maintain my margin because my originally at 80 I had a $20 buffer. Ifthe price goes down 90, if I want my same$20 buffer I'm going to ask you for another $10 because I want to make sure that the amountand the time for liquidation is enough to keep me comfortable when I’m lending youthe money. Hypothecation, rehypothecation is the ability to lend up stock that is borrowed.It’s commoditized business but it’s still big business. All this stuff has been aroundfor a long time. It’s not the sexy stuff but it helps trading get done and if you lookthe one of the things that caused downfall for Lehman, look at repo 105, just go Googlethat and that’s the famous case of how they were leveraging stuff off-balance sheet whichmeant that the bank was much more levered than it looked like in financial statementsbecause a lot of those repo transactions were off-balance sheet transactions, doesn’tshow in the spread sheets. So like I said go Google repo 105, it will give you a goodexplanation in that.

54. Investment Banking X

55. Investment Banking X So we move on to research functions. So there is macroeconomic research, you have much morefor interest rates, currencies and this general trends we believe the stock market as a wholeis going up and down macrotrends Then there’s industry specialist and then there’s specificissuer. Either companies, municipalities, revenue bonds, you’ve got the lottery ticketfinance and lottery winning financing, tobacco, different kind of settlements for investors.So everything can be issued against every such people for that, as kind of applies you got to just look into data [unintelligible] and try to find stuffs where other peoplehaven’t found stuff and it was right, you have to be able to convey and be convincing. So we’re going to go to risk management now. The risk management as one of the majorfunctions of the bank. Credit risk, abilities to repay what you borrowed. Credit risk asI mentioned earlier can be just a swap line of credit where is the bond market in your favor when you owed money. How much should I give them? So loss is composed of two factors.What's the probability of loss and what's my loss given default or one minus the recoveryrate. If my recovery rate is very high I don’t know my loss given default is very low, it’sless risk. So there’s also lots of ways the banks try to figure out, what’s my probabilityof loss and what is my recovery rate? You know how to figure out how much capital Ineed against a trade for example. How profitable is the business and this historical informationyou can look at, with some fundamental analysis financial ratios and there's model-based waysto try to figure it out what the risk of default is. This is the classic value-at-risk graph. Expected loss this is saying okay, if a company is triple B company over time historicallytriple B companies have default rate of X, recovery of Y I can sit here and say okaythat’s going to be a one and a half percent over 10-year period. That’s what I expectif I had a portfolio of total events. Unexpected loss, what’s the variability of that? Theydon’t all default at one and a half percent. If I wanted a 98% confidence level, what wouldthat be?

56. Investment Banking X I have enough capital to cover that arability. Then you have the exceptional losslike one catastrophic things happen. A definition is then expected from those, but this is what—theseare terms that are used when we’re talking about expected loss, unexpected loss basedon value at risk, not so much of people use and people argue whether it’s good metric.What’s the argument about, just because it’s measurable doesn’t means it’s good,it’s accurate. It means it’s measurable, the question is this is this the right measureto use and there are people who are very much against using value-at-risk because a lot of the models of value-at-risk only look at the past 12 months of data for that volatility. That’s not even an economic cycle. So that’s what one of my [unintelligible] about usingvalue-at-risk. You should be based on several economic cycles, depending on what you’relooking at so that gap is 20 years, pick a number. So Moody’s is one of the more well-knownagencies and when they make a product they’ll give a rating based on what the expected lossis. They have the model they say okay this product will have expected loss and it’sa function of rating and tenure on maturity of the product. This is all published stuffs. What I find interesting is that for the same rating, so this is accumulative expected loss.So as you’d expect I’m using easier number let’s say 81. You would expect that this81 would be over 10 years, you can have a lot more risk accumulative over 10 yearthan one year, makes sense. There’s more volatility it’s just worse. However, what’sinteresting if you annualize the 10 year rate, you get it to one year rate, it’s stillhigher, you know there’s a term structure of expected loss for the ratings. So if I hold, if I buy a one year bond or I hold a 10 year bond for one year. My expected lossfor the 10-year bond even for the same holding period is higher. I just find it interestingmaybe [unintelligible] So first thing we talk about is credit risk, very binary. You paybe back the money over a set period of time, credit risk. The other risk is called market risk. What’s the volatility of that price during that time. So all risk management departmentsand all banks have separate groups for doing that, reporting for the same risk point ofview, but very different groups. Creditors we’ve talked about so far and market riskbecause if I look at if I look at the currency, currency doesn’t default, it just movesaround.

57. Investment Banking X But if I’m lending money against something and it’s in different currency I’ll be able to measure what my expected loses are and the counterparty goes away.So here I’m looking at the volatility of market prices versus just a binary loss basedon to pay me back or not. So if I’m a bank I’m Morgan Stanley. I trade with a hedgefund, I only want so much exposure I’m willing to give them for trading. So I based at theasset class I’m looking at and measure the volatility to see what that risk could be. So that’s the definition of market risk. So institutions are just looking at the pricesrisk, if you look at the treasury of a bank there’s also asset liability risk. There’sliquidity risk. There’s a famous term if they run in a bank which means and there’sno bank in this country that in every single depositor went there and tried to withdrawtheir money at the same time. There’s no bank that can give everyone their money back. No one keeps that kind of cash around, which is why people are afraid of a run in a bank, what destabilize entire financial. So that is why confidence in the financial systemso important. If there’s run in a bank, okay people will wait on line, try to taketheir money, majority of them won’t get their money back. So what you’re going todo is avoid a run in the bank by having confidence public having confidence if they won’t run in the bank or else you have liquidity risk okay. I just put this term up there becausea lot of people love returning negative convexity and that’s most useful mortgages and you describe that just kind of a long way trade and how you manage that. Good example. So you have a fixed rate mortgage and you got a 30-year mortgage you could befinancing anytime during the mortgage. It’s called prepayment risk. So when are you goingto refinance your mortgage, it may go up or it may go down. So I’m a bank, I lend youmoney at 10%, money goes down interest down to 6%, you could be financed. Well, if I lendyou money before, how am I going to make up that 4% difference now because I already oweyou. One way you pay the mortgage, I’ve hedged somewhere else a lot of money. So this is what they call negative convexity, it goes against you as a bank. Good for the persontaking up the mortgage, bad for the bank. How do I manage that risk, so I have all these models to figure out okay, when people refinance because there a cost of that you know to refinancethat for you because there’s additional closing cost and all these stuff.

58. Investment Banking X So the ideais to figure out where interest rates will go, given where interest rates are going to go, whose going to be financing it? What’s my risk as a bank? So that’s and okay anasset liability management. The third leg of risk is operational risk and this is moredealt with at high level the bank. Human risk, so when you work at a bank, the good thingis compared to most jobs you get like four to six weeks of vacation. Typical American job you get two weeks of vacation and if you’re in front office you’re forced to take atleast a single block of two weeks where you can’t communicate with the bank. You’re trader, you’re structurer you’re whatever. The reason is if you did let’s just say a phoney trade there should be enough time for them to discover that while you’re onvacation, so human risk. There’s human risk or people putting them in wrong orders, okay.They pushed called fat finger, you put the wrong number in. So people have lost—bankshave lost millions of dollars because they used wrong symbol to buy or sell wrong thingor they used—the decimal place in the wrong place or the comma in the wrong place. Sothat’s human operational risk, but people can screw up. Some intentionally and somenot, still human risk. Then there’s IT infrastructure risk. Process risk and governance okay. Thoseare softer but if you look at the beating that Bank of America has taken over the last several years, okay. That’s governance and process, in other words the incentive systemyou can say is what caused lot of the problems with Bank of America. Other banks are alsopart, I’ll just pick Bank of America because it’s had a lot of press. So they—I’m not sure if you’ve heard, but some of their sales people would create phoney accountsfor their client okay, give them credit line they didn’t ask for or credit cards or whathave you because they’re meeting their goals for sales. That’s a governance issue, that’sa process issue. How is that ever possible, how to then prove that the customer agreeto it. So let’s break down the process and the break down in governance is having a systemthat use the term forced but not sales people do it in order to survive do these fraudulentactivities. So this is when the fish stinks from the head down is poor governance. You can say the same for subprime. We get to government process in governance you as senior managementallow these what you call [unintelligible] they don’t verify your income. Why shouldthat be? So that goes for, so all comes under operational risk.

59. Investment Banking XI

60. Investment Banking XI So define risk? What do they do day-to-day? What'sthe work product of the different risk functions? Credit risk management as a bankor as division fixed income or commercial bank you said you said limits okay as a bankI'm going to set X amount of limit by country by industry and by issuer becauseI want to make sure I have diversified, need to be granularportfolio at the end of the day can minimize risk to minimize capital requirement to maximizemy return on capital as an institution [unintelligible] so how can you look at? They have their own internal rating score, they look at outside rating agencies for the countryfor example or you issuer. They have other modeling techniques to figure out what thecredit the credit worthiness is. This is what credit risk management figures outexcept limits. What's interesting is that for ratings point of view they used to have what theycall a sovereign ceiling. So there should be no issuer or company inany country which has a higher credit rating than the country it's in. If I’ma company in the US, how can I be rated higherthan country? It’s happened before, it was Pemex in Northern Hemis, it was an Mexicanoil company. They were consider actually stronger than the country itself, so that company oilcompany the Mexican oil company had a higher rating than the country. So it was able tobreak the debt ceiling, see if the sovereign ceiling for the rating. So always exceptions to the rules, so what does risk market risk management do? They set trading limits. They do stress testing, look at portfolios and say okay under different scenarios do we haveenough capital based on how we limit the counterparty risk to theamount that we’re lending against different securities. So value-at-risk is all basic,so trust—stress test scenario example would be okay, I'm going to look at different pointin time, 1987 Black Monday, Friday, Monday, I look at Asian crisis 1997, look at Russiancrisis 1998. I look at the recession of 91. I look at internet bubble 2000. So you look at all the differences you look empirically what happened to the stockmarket at each of these situations. What happened to the currency, interest market. What happenedto the bond market? You sit there and say okay under all these scenarios, if I reimposethose same scenarios on my current portfolio, howwould it react?

61. Investment Banking XI This would mean stress testing on this historical stress situation I'm goingto have the same losses or worse losses to see how my portfolio would react if thatwould happen again. So that's what stress testing is. When I look market risk I alsolook at hedging. So for example if you look at the correlation between Russia CDS andyou look at oil pricing is pretty much correlated because whatever the number is I don’t knowoff head, but there’s a high correlation between the performance of Russian and oilbecause their main export industry is oil. So I used to know an old friends of mine thatwould hedge their overnight exposure to Russia by trading in oil as a proxy hedge. Obviously, that introduces basis risk, this is not one-to-one but maybe for overnight over short periodwhen there's nothing happening in the markets, you can reasonable assume it could be reasonableto use them as a hedge. So I've always said that if you live by the model, you die bythe model. So you’re only as good as your model. So doing all those risk managementstuff you have to figure you know one of the things I'm always aware of this survivorshipbias, the data that you use is based on what survives. This is an old trick that hedgefunds use for example. So when you start a hedge fund or mutual fund the idea is okayhis good track record, this is my performance. So what they do is they if if my fund is doingbadly I shut my old fund down, open a new fund and reset myself and get a better returnprofile for my performance, but I never get to see the one that failed because you tookthat out, so this is all you see is just the survivorshipbias of the funds that are doing well and they just bury the bad one. So don't know their entire performance, that's marvellous also. So what does these people do? They writefederal reports. There’s combination of qualitative and quantitative especially whenyou look at credit risk. They're analyzing balance sheets to see how much marginyou given them based on financial ratios and do some modeling, some stats, life asa risk manager and it's getting more important after the last crisis because previously risk managementused to report to a finance or Treasury. After the crisis risk managers report directly topresidents. So they realized that it's more important function in the sameway sales is or trading, so it's moved up thehierarchy. Compliance functions is making sure that the banks follow regulatory rules,care for your relations. So Patriot Act after 9/11 because of money laundering, make sure we'renot financing terrorists. That's all the know your client, KYC.

62. Investment Banking XI Compliance also wants toavoid insider trading, so make sure that neither yourclients nor your firm is engaging in insider trading. Dodd-Frank as a resultof 2009 crisis is the legislation that includes Volker rule and the Volker rule is to saythat trading companies should not be trading from their own account, no proprietarytrading and compliance also will make sure that all the proper licensing is done beforepeople are licensed to do the job suite seven and allthose [unintelligible] states I mean Federal government require—so what is there to lookin compliance? Writing skills, talk about policies. Somefirm I’ve worked at required firms to be lawyers [unintelligible] So US regulatoryhistory, this every once in a while this comes on. Glass-Steagall 93 after depression wasseparation of commercial and investment banking activities. So if you look at Morgan Stanley,J.P. Morgan it’s the same mortgage family. The idea is that when you have a commercialbank you have FDIC insurance which is Federal Depository Insurance Corporation whichprovides insurance for all bank accounts; savings accounts, checking accounts, all thatstuff. So the idea is that the same institution that gets the benefit of this insurance shouldnot be speculating with investors money for trading for their own accounts. So Glass-Steagallsaid okay investment banking which is insured by the governmentFDIC. See retail banking is separate than investment banking where they should not beable to have trading activities for the bank and putting depositors money at risk. By mid 90sthey kind of went away as all the [unintelligible] from the financial group. Black Monday in1987 it started to bring in trading limits because by then all the program trading helpedexacerbate the program, kept selling selling down selling down, say okay let’s stop itand put some stop gaps in it so that more rational heads calm the market down. So Sarbanes-OxleyAct in 2000 was because of Denmark and a little bit it was because what they realized wasthat the research analyst were promoting research that they didn’t believe let’s saybecause they were paid to promote the stuffs. So this is about governance good governance. So the financial statement had to be also signedby the CEO and CFO and there are test to validity of financial statements, so those are thetwo major things.

63. Investment Banking XI Research analyst had to dispose any investments or relationship theyhave with the firm that they’re doing research on and the CEO and the CFO have to personallysign off on financial statements for the company. So Dodd-Frank was the result of 2009 crisisand one of the big concern is that oh, the bailouts for AIG, the bailout Citibank andall these bailouts. Should we ensure one of the things we want to do is make sure institutionsaren’t to big to fail that will require the government bailout again. The irony isthis pre-crisis the six largest banks held 37% of US assets. After crisis 2015 67%. Soit was too big to fail at 37 it’s definitely too big to fail at 67% because look at allthe mergers that happened as a result of the crisis. Merrill was bought by Bank of America.Bear Sterns was bought by J.P. Morgan. All these mergers happened right because the weakerones had to be absorbed by the bigger ones. So now you’ve created much larger too bigto fail banks. You said there’re not good regulations, this doesn’t seem to work outreally well, if your goal is to decrease the risk now through all these regulations youcan enforce will actually increase the risk. Irony in conversation who manages who regulatesbanks? The Federal reserve, no the Fed, Office of Comptroller of Currency and state bankingregulations. Capital requirements are done. Industry group called the BIS out of Baselis what they have for risk management and capital requirement for OECD banks and that’sfor merger [unintelligible] Banks you know because of regulatory capital, how much capitaldo you need to satisfy your regulators. Banks generally don’t manage business that ways. Banks manage based on economic capital. So it’s kind of different universe, say okaywhat businesses should I grow, what business should I shrink or get out based on how profitableit is and what I feel the economic risk is, know all the regulatory capital requirement are.So regulatory capital versus economic capital. This kind of stuff I just touch on lightlyjust so you hear the terms. You know to look it up and there is difference and number twothat these terms exist. So we talked about markets, what do they mean? Over the countermarkets or exchanges. Over the counter means that private transactions, exchanges are moreself-explanatory, stock exchanges are electronic physical. Clearing houses, where you wantto trade.

64. Investment Banking XI Again, to reduce risk, so the idea is that everyone transacts the same clearinghouseand there’s lot of [unintelligible] and there’s also transparency. So trace meansthat every time a bond is traded it has to be reported within X amount of time. I passedthe test too many years ago to remember what the requirement are. So it just means thatthe prices are reported and everyone can see and because of that transparency the bid askrequirement have decreased by half since [unintelligible] requires because unlike the stock market I can actually see hey these are the prices and here’s the bid/ask, bonds are generallynot traded in the exchange, so you know there’s no price discovery. So they say okay in orderto actually increase transparency we do mandatory reporting because there’s no exchanges forthe bond markets.