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  • 1. INTERNATIONAL INSTITUTE OF PROFESSIONAL STUDIES Investment Management FINANCE CONCEPTSAssigned by: Presented by:Mrs. Kalyani Parmal Ankur Pandey MBA (MS) 5yrs. IM-2K8-007
  • 2. Contents1. Private Equity2. Venture Capital3. Hedge Fund4. Real Estate Investment Trust – REIT5. Pension Fund6. Securitization7. Capping8. Floor Planning9. Collar10. Bridge Financing11. AG Mezzanine Financing12. Algorithmic Trading13. Leveraged portfolio
  • 3. Private EquityIn finance, private equity is an asset class consisting of equity securities inoperating companies that are not publicly traded on a stock exchange.A private equity investment will generally be made by a private equity firm,a venture capital firm or an angel investor. Each of these categories of investor hasits own set of goals, preferences and investment strategies; however, all provideworking capital to a target company to nurture expansion, new productdevelopment, or restructuring of the company’s operations, management, orownership.Bloomberg Business Week has called private equity a rebranding of leveragedbuyout firms after the 1980s. Among the most common investment strategies inprivate equity are: leveraged buyouts, venture capital, growth capital, distressedinvestments and mezzanine capital. In a typical leveraged buyout transaction, aprivate equity firm buys majority control of an existing or mature firm. This isdistinct from a venture capital or growth capital investment, in which the investors(typically venture capital firms or angel investors) invest in young or emergingcompanies, and rarely obtain majority control.Private equity is also often grouped into a broader category called private capital,generally used to describe capital supporting any long-term, illiquid investmentstrategy.Strategies 1. Leveraged buyout 2. Simple example 3. Growth Capital 4. Mezzanine Capital 5. Venture Capital 6. Distressed and Special situations 7. Secondaries 8. Other Strategies
  • 4. Venture CapitalVenture capital (VC) is financial capital provided to early-stage, high-potential,high risk, growth startup companies. The venture capital fund makes money byowning equity in the companies it invests in, which usually have a noveltechnology or business model in high technology industries, suchas biotechnology, IT, software, etc. The typical venture capital investment occursafter the seed funding round as growth funding round (also referred to as Series Around) in the interest of generating a return through an eventual realization event,such as an IPO or trade sale of the company. Venture capital is a subset of privateequity. Therefore, all venture capital is private equity, but not all private equity isventure capital.[1]In addition to angel investing and other seed funding options, venture capital isattractive for new companies with limited operating history that are too small toraise capital in the public markets and have not reached the point where they areable to secure a bank loan or complete a debt offering. In exchange for the highrisk that venture capitalists assume by investing in smaller and less maturecompanies, venture capitalists usually get significant control over companydecisions, in addition to a significant portion of the companys ownership (andconsequently value).Venture capital is also associated with job creation (accounting for 2% of USGDP), the knowledge economy, and used as a proxy measure of innovation withinan economic sector or geography. Every year, there are nearly 2 million businessescreated in the USA, and 600–800 get venture capital funding. According tothe National Venture Capital Association, 11% of private sector jobs come fromventure backed companies and venture backed revenue accounts for 21% of USGDP.It is also a way in which public and private actors can construct an institution thatsystematically creates networks for the new firms and industries, so that they canprogress. This institution helps in identifying and combining pieces of companies,like finance, technical expertise, know-how of marketing and business models.Once integrated, these enterprises succeed by becoming nodes in the searchnetworks for designing and building products in their domain.
  • 5. Hedge FundA hedge fund is an investment fund that can undertake a wider range ofinvestment and trading activities than other funds, but which is generally only opento certain types of investors specified by regulators. These investors are typicallyinstitutions, such as pension funds, university endowments and foundations, orhigh-net-worth individuals, who are considered to have the knowledge or resourcesto understand the nature of the funds. As a class, hedge funds invest in a diverserange of assets, but they most commonly trade liquid securities on public markets.They also employ a wide variety of investment strategies, and make use oftechniques such as short selling and leverage.Hedge funds are typically open-ended, meaning that investors can invest andwithdraw money at regular, specified intervals. The value of an investment in ahedge fund is calculated as a share of the funds net asset value, meaning thatincreases and decreases in the value of the funds investment assets (and fundexpenses) are directly reflected in the amount an investor can later withdraw.Most hedge fund investment strategies aim to achieve a positive return oninvestment whether markets are rising or falling. Hedge fund managers typicallyinvest their own money in the fund they manage, which serves to align theirinterests with investors in the fund.[1][2] A hedge fund typically pays its investmentmanager a management fee, which is a percentage of the assets of the fund, anda performance fee if the funds net asset value increases during the year. Somehedge funds have a net asset value of several billion dollars. As of 2009, hedgefunds represented 1.1% of the total funds and assets held by financialinstitutions. As of April 2012, the estimated size of the global hedge fund industrywas US$2.13 trillion.Because hedge funds are not sold to the public or retail investors, the funds andtheir managers have historically not been subject to the same restrictions thatgovern other funds and investment fund managers with regard to how the fund maybe structured and how strategies and techniques are employed. Regulations passedin the United States and Europe after the 2008 credit crisis are intended to increasegovernment oversight of hedge funds and eliminate certain regulatory gaps.
  • 6. Real Estate Investment Trust – REITA real estate investment trust (―REIT‖), generally, is a company that owns – andtypically operates – income-producing real estate or real estate-relatedassets. REITs provide a way for individual investors to earn a share of the incomeproduced through commercial real estate ownership – without actually having togo out and buy commercial real estate. The income-producing real estate assetsowned by a REIT may include office buildings, shopping malls, apartments, hotels,resorts, self-storage facilities, warehouses, and mortgages or loans.Most REITs specialize in a single type of real estate – for example, apartmentcommunities. There are retail REITs, office REITs, residential REITs, healthcareREITs, and industrial REITs, to name a few. What distinguishes REITs from otherreal estate companies is that a REIT must acquire and develop its real estateproperties primarily to operate them as part of its own investment portfolio, asopposed to reselling those properties after they have been developed.To qualify as a REIT, a company must have the bulk of its assets and incomeconnected to real estate investment and must distribute at least 90 percent of itstaxable income to shareholders annually in the form of dividends. In addition topaying out at least 90 percent of its taxable income annually in the form ofshareholder dividends, a REIT must: Be an entity that would be taxable as a corporation but for its REIT status; Be managed by a board of directors or trustees; Have shares that are fully transferable; Have a minimum of 100 shareholders after its first year as a REIT; Have no more than 50 percent of its shares held by five or fewer individuals during the last half of the taxable year; Invest at least 75 percent of its total assets in real estate assets and cash; Derive at least 75 percent of its gross income from real estate related sources, including rents from real property and interest on mortgages financing real property; Derive at least 95 percent of its gross income from such real estate sources and dividends or interest from any source; and Have no more than 25 percent of its assets consist of non-qualifying securities or stock in taxable REIT subsidiaries.
  • 7. REITs generally fall into three categories: equity REITs, mortgage REITs, andhybrid REITs. Most REITs are equity REITs. Equity REITs typically own andoperate income-producing real estate. Mortgage REITs, on the other hand, providemoney to real estate owners and operators either directly in the form of mortgagesor other types of real estate loans, or indirectly through the acquisition ofmortgage-backed securities. Mortgage REITs tend to be more leveraged (that is,they use a lot of borrowed capital) than equity REITs. In addition, many mortgageREITs manage their interest rate and credit risks through the use of derivatives andother hedging techniques. You should understand the risks of these strategiesbefore deciding to invest in these types of REITs. Hybrid REITs generally arecompanies that use the investment strategies of both equity REITs and mortgageREITs.Many REITs (whether equity or mortgage) are registered with the SEC and arepublicly traded on a stock exchange. These are known as publicly tradedREITs. In addition, there are REITs that are registered with the SEC, but are notpublicly traded. These are known as non-traded REITs (also known as non-exchange traded REITs). You should understand the risks of the different types ofREITs and their strategies before deciding to invest in them.As with any investment, you should take into account your own financial situation,consult your financial adviser, and perform thorough research before making anyinvestment decisions concerning REITs. You can review a REIT’s disclosurefilings, including annual and quarterly reports and any offering prospectusat You can invest in a publicly traded REIT, which is listed on a majorstock exchange, by purchasing shares through a broker (as you would otherpublicly traded securities). Generally, you can purchase the common stock,preferred stock, or debt securities of a publicly traded REIT. You can purchaseshares of a non-traded REIT through a broker that has been engaged to participatein the non-traded REIT’s offering. You can also purchase shares in a REIT mutualfund (either an index fund or actively managed fund) or REIT exchange-tradedfund.Source:
  • 8. Pension FundA pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They areespecially important to the stock market where large institutionalinvestors dominate. The largest 300 pension funds collectively hold about $6trillion in assets. In January 2008, The Economist reported that MorganStanley estimates that pension funds worldwide hold over US$20 trillion in assets,the largest for any category of investor ahead of mutual funds, insurancecompanies, currency reserves, sovereign wealth funds, hedge funds, or privateequity. Although the (Japan) Government Pension Investment Fund (GPIF) lost0.25 percent, in the year ended March 31, 2011 GPIF was still the worlds largestpublic pension fund which oversees 114 trillion Yen ($1.5 trillion).Classifications: 1. Open vs. closed pension fundsOpen pension funds support at least one pension plan with no restriction onmembership while closed pension funds support only pension plans that are limitedto certain employees.Closed pension funds are further sub-classified into: Single employer pension funds Multi-employer pension funds Related member pension funds Individual pension funds
  • 9. 2. Public vs. private pension fundsA public pension fund is one that is regulated under public sector law while aprivate pension fund is regulated under private sector law. In certain countries thedistinction between public or government pension funds and private pension fundsmay be difficult to assess. In others, the distinction is made sharply in law, withvery specific requirements for administration and investment. For example, localgovernmental bodies in the United States are subject to laws passed by the states inwhich those localities exist, and these laws include provisions such as definingclasses of permitted investments and a minimum municipal obligation
  • 10. SecuritizationSecuritization is the financial practice of pooling various types of contractual debtsuch as residential mortgages, commercial mortgages, auto loans or credit carddebt obligations and selling said consolidated debt as bonds, pass-throughsecurities, or Collateralized mortgage obligation (CMOs), to various investors. Theprincipal and interest on the debt, underlying the security, is paid back to thevarious investors regularly. Securities backed by mortgage receivables arecalled mortgage-backed securities (MBS), while those backed by other types ofreceivables are asset-backed securities (ABS).Critics have suggested that the complexity inherent in securitization can limitinvestors ability to monitor risk, and that competitive securitization markets withmultiple securitize may be particularly prone to sharp declines in underwritingstandards. Private, competitive mortgage securitization is believed to have playedan important role in the U.S. subprime mortgage crisis.In addition, off-balance sheet treatment for securitizations coupled with guaranteesfrom the issuer can hide the extent of leverage of the securitizing firm, therebyfacilitating risky capital structures and leading to an under-pricing of credit risk.Off-balance sheet securitizations are believed to have played a large role in thehigh leverage level of U.S. financial institutions before the financial crisis, and theneed for bailouts.The granularity of pools of securitized assets is a mitigant to the credit risk ofindividual borrowers. Unlike general corporate debt, the credit quality ofsecuritized debt is non-stationary due to changes in volatility that are time- andstructure-dependent. If the transaction is properly structured and the pool performsas expected, the credit risk of all tranches of structured debt improves; ifimproperly structured, the affected tranches may experience dramatic creditdeterioration and loss.Securitization has evolved from its tentative beginnings in the late 1970s to anestimated outstanding of $10.24 trillion in the United States and $2.25 trillion inEurope as of the 2nd quarter of 2008. In 2007, ABS issuance amounted to $3.455trillion in the US and $652 billion in Europe. WBS (Whole BusinessSecuritization) arrangements first appeared in the United Kingdom in the 1990s,
  • 11. and became common in various Commonwealth legal systems where seniorcreditors of an insolvent business effectively gain the right to control the company.
  • 12. CappingDefinition 1. The practice of selling large amounts of a commodity or security close to the options expiry date in order to prevent a rise in market price. 2. It is an attempt to keep a stocks price low or move its price lower by putting selling pressure on it.Investopedia explains Capping 1. The investor who might practice capping is a call option writer. If practicing capping, he or she is trying to avoid having to transfer the underlying security or commodity to the option holder. The goal is to have the option expire worthless so that the premium initially received by the writer is protected. 2. This is a violation of NASD rules. Source:
  • 13. CollarIn finance, a collar is an option strategy that limits the range of possible positive ornegative returns on an underlying to a specific range. 1. Equity CollarStructureA collar is created by an investor being: Long the underlying long a put option at strike price X (called the "floor") Short a call option at strike price (X+a) (called the "cap")These latter two are a short Risk reversal position. So: Underlying - Risk reversal = CollarThe premium income from selling the call reduces the cost of purchasing the put.The amount saved depends on the strike price of the two options. If the premium ofthe short call is exactly equal to the cost of the put, the strategy is known as a zero-cost collar. [Strictly speaking the name should be zero-premium collar since thecost of holding the position may be high if the price of the underlying rises abovethe strike level of the call.]On expiry the value (but not the profit) of the collar will be:  X if the price of the underlying is below X  positive if the price of the underlying is between X and (X + a)The maximum value occurs for any price of the underlying above X+a.
  • 14. 2. Interest Rate CollarStructureIn an interest rate collar, the investor seeks to limit exposure to changing interestrates and at the same time lower its net premium obligations. Hence, the investorgoes long on the cap (floor) that will save it money for a strike of X +(-) S1 but atthe same time shorts a floor (cap) for a strike of X +(-) S2 so that the premium ofone at least partially offsets the premium of the other. Here S1 is the maximumtolerable unfavorable change in payable interest rate and S2 is the maximumbenefit of a favorable move in interest rates.[2]ImportanceIn times of high volatility, or in bear markets, it can be useful to limit the downsiderisk to a portfolio. One obvious way to do this is to sell the stock. In the aboveexample, if an investor just sold the stock, the investor would get $5. This may befine, but it poses additional questions. Does the investor have an acceptableinvestment available to put the money from the sale into? What are the transactioncosts associated with liquidating the portfolio? Would the investor rather just holdonto the stock? What are the tax consequences?If it makes more sense to hold onto the stock (or other underlying asset), theinvestor can limit that downside risk that lies below the strike price on the put inexchange for giving up the upside above the strike price on the call. Anotheradvantage is that the cost of setting up a collar is (usually) free or nearly free. Theprice received for selling the call is used to buy the put—one pays for the other.Finally, using a collar strategy takes the return from the probable to the definite.That is, when an investor owns a stock (or another underlying asset) and hasan expected return, and that expected return is only the mean of the distribution ofpossible returns, weighted by their probability. The investor may get a higher orlower return. When an investor who owns a stock (or other underlying asset) uses acollar strategy, the investor knows that the return can be no higher than the returndefined by strike price on the call, and no lower than the return that results fromthe strike price of the put.
  • 15. Floor PlanningDefinitionIt is a form of financing pertaining specifically to inventory. A lender will purchasethe inventory from the borrower and as the inventory sells, the borrower will repaythe debt. It is essential that the creditworthiness of both parties is established andthat a procedure for if the inventory does not sell is in place before the lendingtakes place.Investopedia explains Floor PlanningThis type of financing began in the automobile industry as the purchase price forvehicles was high and standard financing was hard to obtain. Its popularity spreadto home appliances and finally to large-scale home electronics such as personalcomputers.Source: Derivatives - Interest Rate Caps and FloorsInterest Rate CapAn interest rate cap is actually a series of European interest call options (calledcaplets), with a particular interest rate, each of which expire on the date thefloating loan rate will be reset. At each interest payment date the holder decideswhether to exercise or let that particular option expire. In an interest rate cap, theseller agrees to compensate the buyer for the amount by which an underlying short-term rate exceeds a specified rate on a series of dates during the life of the contract.Interest rate caps are used often by borrowers in order to hedge against floatingrate risk.Formula: (Current market rate - Cap Rate) x principal x (# days to maturity/360)
  • 16. Interest Rate FloorFloors are similar to caps in that they consist of a series of European interest putoptions (called caplets) with a particular interest rate, each of which expire on thedate the floating loan rate will be reset. In an interest rate floor, the seller agrees tocompensate the buyer for a rate falling below the specified rate during the contractperiod. A collar is a combination of a long (short) cap and short (long) floor, struckat different rates. The difference occurs in that on each date the writer pays theholder if the reference rate drops below the floor. Lenders often use this method tohedge against falling interest rates.The cash paid to the holder is as follows:(Floor rate - Current market rate) x principal x (# days to maturity/360)Source:
  • 17. Bridge FinancingBridge financing is a method of financing, used to maintain liquidity whilewaiting for an anticipated and reasonably expected inflow of cash. Bridgefinancing is commonly used when the cash flow from a sale of an asset is expectedafter the cash outlay for the purchase of an asset. For example, when sellinga house, the owner may not receive the cash for 90 days, but has already purchaseda new home and must pay for it in 30 days. Bridge financing covers the 60 day gapin cash flows.Another type of bridge financing is used by companies before their initial publicoffering, to obtain necessary cash for the maintenance of operations. These fundsare usually supplied by the investment bank underwriting the new issue. Aspayment, the company acquiring the bridge financing will give a numberof stocks at a discount of the issue price to the underwriters that equally offset theloan. This financing is, in essence, a forwarded payment for the future sales of thenew issue.Bridge financing may also be provided by banks underwriting an offeringof bonds. If the banks are unsuccessful in selling a companys bonds to qualifiedinstitutional buyers, they are typically required to buy the bonds from the issuingcompany themselves, on terms much less favorable than if they had beensuccessful in finding institutional buyers and acting as pure intermediaries.There are two types of bridging finance. Closed bridging and Open Bridging.Closed bridging finance is where you have a date for the exit of the bridgingfinance and are sure that the bridging finance can be repaid on that date. This isless risky for the lender and thus the interest rates charged are lower.Open bridging is higher risk for the lender. This is where the borrower does nothave an exact date for the bridging finance exit and may be looking for a buyer ofthe property or land.
  • 18. Mezzanine FinancingMezzanine capital, in finance, refers to a subordinated debt or preferredequity instrument that represents a claim on a companys assets which is senioronly to that of the common shares. Mezzanine financings can be structured eitheras debt (typically an unsecured and subordinated note) or preferred stock.Mezzanine capital is often a more expensive financing source for a companythan secured debt or senior debt. The higher cost of capital associated withmezzanine financings is the result of it being an unsecured, subordinated (orjunior) obligation in a companys capital structure (i.e., in the event of default, themezzanine financing is only repaid after all senior obligations have been satisfied).Additionally, mezzanine financings, which are usually private placements, areoften used by smaller companies and may involve greater overall leverage levelsthan issuers in the high-yield market; as such, they involve additional risk. Incompensation for the increased risk, mezzanine debt holders require a higher returnfor their investment than secured or more senior lenders. Swiss Finance Partners AG MEZZANINE FINANCING Mezzanine Financing ConceptsWe do offer different concepts of so called Mezzanine financing which presents away for publicly and privately held companies to attain financing without goingpublic and potentially ceding ownership of their company.It is a blend of traditional debt financing and equity financing, reaping somebenefits of both. Like equity financing, mezzanine financing is an unsecured debt,requiring no collateral to be put up unlike traditional bank loans.Like debt financing, mezzanine financing is very fluid and does not necessarilyinvolve giving up an interest in the company.Mezzanine financing relies on very high interest rates in the 5 - 10% range tomake it profitable.Unlike a bank loan, mezzanine financing does not hold real assets of a company ascollateral; instead, lenders offering mezzanine financing have the right to converttheir stake to an equity or ownership in the event of a default on the loan.
  • 19. Mezzanine financing is a particularly appealing form of liquidity for owners ofprivately held companies. It is traditionally understood that a privately heldcompany simply cannot achieve the same sort of fluid capital flow as a publiclyheld company, therefore mezzanine financing offers a way to balance that situationwithout going public.In addition to the fact that mezzanine financers do not retain an interest in thecompany except in the event of a default, there is also the important considerationthat they actively do not want an interest in the company.While traditional equity investors are often striving towards some level of control,a displeasing thought to many private owners, with mezzanine financing one canrest assured that the financiers will do what they can to ensure you pay off yourdebt without resorting to default.Because of the lack of real collateral, as well as the high speed oflending, mezzanine financing is typically more difficult to receive than atraditional bank loan or equity financing.A company must demonstrate an established track record in its industry, show aprofit or at the very least post no loss, and have a strong business plan for futureexpansion. Because of these limitations; mezzanine financing is not for everybusiness.However for businesses looking for a quick injection of capital to grow theiralready successful business, without giving up an interest, mezzanine financing canbe an ideal solution.Source:
  • 20. Algorithmic TradingAlgorithmic trading, also called automated trading, black-box trading, or algotrading, is the use of electronic platforms for entering trading orders withan algorithm deciding on aspects of the order such as the timing, price, or quantityof the order, or in many cases initiating the order without human intervention.Algorithmic trading is widely used by pension funds, mutual funds, and other buy-side (investor-driven) institutional traders, to divide large trades into severalsmaller trades to manage market impact and risk. Sell side traders, such as marketmakers and some hedge funds, provide liquidity to the market, generating andexecuting orders automatically.A special class of algorithmic trading is "high-frequency trading" (HFT), in whichcomputers make elaborate decisions to initiate orders based on information that isreceived electronically, before human traders are capable of processing theinformation they observe. This has resulted in a dramatic change of the marketmicrostructure, particularly in the way liquidity is provided.Algorithmic trading may be used in any investment strategy, including marketmaking, inter-market spreading, arbitrage, or pure speculation (including trendfollowing). The investment decision and implementation may be augmented at anystage with algorithmic support or may operate completely automatically.A third of all European Union and United States stock trades in 2006 were drivenby automatic programs, or algorithms, according to Boston-based financialservices industry research and consulting firm Aite Group. As of 2009, HFT firmsaccount for 73% of all US equity trading volume.In 2006, at the London Stock Exchange, over 40% of all orders were entered byalgorithmic traders, with 60% predicted for 2007. American markets and Europeanmarkets generally have a higher proportion of algorithmic trades than othermarkets, and estimates for 2008 range as high as an 80% proportion in somemarkets. Foreign exchange markets also have active algorithmic trading (about25% of orders in 2006). Futures and options markets are considered fairly easy tointegrate into algorithmic trading with about 20% of options volume expected to becomputer-generated by 2010. Bond markets are moving toward more access toalgorithmic traders.
  • 21. One of the main issues regarding HFT is the difficulty in determining howprofitable it is. A report released in August 2009 by the TABB Group, a financialservices industry research firm, estimated that the 300 securities firms and hedgefunds that specialize in this type of trading took in roughly US$21 billion in profitsin 2008.Algorithmic and HFT have been the subject of much public debate since the U.S.Securities and Exchange Commission and the Commodity Futures TradingCommission said they contributed to some of the volatility during the 2010 FlashCrash, when the Dow Jones Industrial Average suffered its second largest intradaypoint swing ever to that date, though prices quickly recovered. (See List of largestdaily changes in the Dow Jones Industrial Average.) A July, 2011 report bythe International Organization of Securities Commissions (IOSCO), aninternational body of securities regulators, concluded that while "algorithms andHFT technology have been used by market participants to manage their trading andrisk, their usage was also clearly a contributing factor in the flash crash event ofMay 6, 2010.
  • 22. Leveraged PortfolioIt is a Portfolio that includes risky assets purchased with funds borrowed.DefinitionA portfolio that includes at least some securities thatwere bought with borrowed money. A leveraged portfolio is risky because thesecurities may result in a loss, which would leave the investor liable to repay theborrowed capital. However, if the securities result in a gain, the investor hasessentially made a profit without using his/her own money.Source: