Company Knowledge

　　Business Description

　　Investment Banking

　　Strategic Advisory

　　Strategic advisory is the central platform of investment banking business where the key objective is to assist company on addition value creation for shareholders. Investment banks typically organize their resources and expertise along major industry groups. Examples include telecommunications, media & broadcasting, pharmaceutical, consumer products, insurance, and banking & financial industry. They have a wealth of institutional experience obtained from working with companies operating similar businesses. Companies engage investment banks to perform strategic review on their businesses pertain to the following aspects:

　　1. Examining its core competency and the performance of the key businesses: How is the company’sperformance compared to its peer group in the industry?

　　2. Is the company effective in leveraging its assets and financial capital?

　　3. Is the company able to attain its stated performance objective and projected financial returns by operating the same way in the next 3 to 5 years?

　　4. What is the outlook for the profit margin on its continuing businesses? Are there products and services in the vertical space worth exploring?

　　Using the business and financial analytic skills, comprehensive industry statistics and data, investment banks help their clients to examine the above strategic issues and consider the various options that will lead to improvement of business and financial performance. These alternatives may include divesting non-core assets and businesses; spinning off non-related but attractive businesses; acquisitions of companies in similar business for additional market share; acquisitions of complementary business to improve profit margin; and raising more debt to improve financial returns.

　　Implementation of any of the above strategies will involve both execution and product expertise. The following is a description of some of the key areas in the investment banking business:

　　Mergers And Acquisitions

　　Mergers & acquisitions occupy an important part of U.S. business scene. Senior executives consider this approach to either access technology, gain market share or extend product line. Since no single company has all the resources to achieve all these organically, merger and acquisitions strategies are being considered as a broad corporate development plan. Investment banks provide the necessary advice including analytical, transactional, and structuring capabilities to assist corporations to achieve their desired objective.

　　Underwriting:

　　Equity Capital Market

　　The ECM works closely with and coordinates investment bankers, research analysts, sales force, as well as ECM teams of other syndicate members on various activities relating to the equity offering transaction. The key functions include pitching for new equity underwriting deals from the perspective of distribution and pricing capability, organizational efficiency, etc. Once the mandate has been received, ECM gets involved with the planning of schedule and filing of the various documents with the various regulatory agencies and stock exchange. ECM will also assist the management of the issuance company on the road-show preparation and setting up key investor meetings through the institutional sales force. For the lead underwriter, its ECM will organize the syndicate(selling group) comprising of sub-underwriters and co-managers. In realty, only the lead manager (underwriter) has the decision making power to decide on allocation. On “hot deals? co-managers usually get little or no allocation. The only benefit is their names get to appear on the “tomb stone?and the prospectus for recognition.

　　Debt Capital Market

　　Debt capital market includes the underwriting and origination of various types of debt instruments that are broadly categorized as follows: Investment grade debt for governments, municipalities, government agencies and corporations; Leveraged finance, which includes high-yield debt and bank loans for non-investment grade issuers; Emerging market debt, which include corporate and sovereign issues; and Asset- backed securities. Each of these areas requires highly focused approach in order to provide high value-added services to clients.

　　Institutional Sales

　　This is the key distribution channel for an investment bank. It is organized according to major product group such as equities, debt, and FX. Within each of these product categories, there are cash and derivative instruments. The strategic advisory work mentioned above may result in creation of securities products, such as corporate debt or equities to fund acquisitions or initial public offering of subsidiaries. Institutional sales force plays an important role to market these securities to institutional investors.

　　Investment Research

　　Investment research provides fundamental business and financial analysis on listed corporations. Investment analysts are highly qualified industry experts armed with CFA qualifications. They interact and visit companies under their coverage regularly to keep a finger on the pulse of the companies and their latest developments. Comparative analyses on companies in the same industry are carried out and investment opinions are formed, expressed in a rating system. Daily research call, conference call and research reports are published and posted on electronic platform for dissemination to institutional and individual clients of the investment banks. These opinions and information are regarded as valuable in terms of making investment decisions. Investment research is also critical to the investment bank’s ability to succeed in the equity underwriting business. High quality equity research is a significant competitive advantage in the market for new equity issues.

　　In addition to equity research, there are also economic research, portfolio strategy, fixed income research and commodities research. The most prestigious annual poll and ranking on research teams is the Institutional Investor’s annual survey.

　　The role of Investment Research in the Investment Bank setting is being closely scrutinized after their integrity, independence, quality and value add is called into serious question, following the contributory role they played in the collapse of internet, technology and telecom stocks when the equity bubble burst in early 2000. The key question is the analysts?independence and how much influence the investment bankers have over their investment opinions. In order to win lucrative investment banking mandates, analysts were deemed to be pressured to give favorable Company opinions. The way the analysts are compensated, which is tied to the amount of investment banking revenues that they help bring in, contributes to the distrust by the investment community of their opinions.

　　The investment banks themselves have changed the way investment research is conducted. In addition to clearer explanations of their stock rating, they have made the firm’s global stock ratings transparent, by declaring how many of the recommended companies under their coverage are investment-banking clients.

　　Globol Stock Ratings Ditribution (as of Sep 30,2002)

　　In addition, to improve the transparency of the analyst’s recommendation, they have introduced a clear and transparent method to track the recommendations?performance against the actual share price of the company. The following graph demonstrates how an Investment Bank would do it.

　　But pressure to further separate the Investment Research function from Investment Banking continued, and this has prompted Citigroup , in Oct. 2002, to form a new independent business unit to provide equity research to their institutional clients and retail clients. This is to ensure that all equity research at Citigroup will be independent of corporate, investment banking and underwriting businesses.

　　Trading

　　A fundamental tenet of the investment banking business is the willingness and ability to take trading and principal investment risks for proprietary account and to facilitate customer transactions. On the trading side, these activities include market-making and trading of fixed income and equity products, currencies, commodities, swaps, structured products, futures and options and other derivatives. Revenues are generated through large and highly liquid principal markets such as the NYSE by undertaking sizeable transactions for modest spreads. On the Nasdaq, investment banks may undertake large size positions for a bigger spread than those on the listed market by using its strong market relationships and capital strength. Frequently, investment banks also execute block trades (trades of 50,000 or more shares) in the U.S. and abroad. The amounts of these block trades can be ranging from US$50 million to US$100 million per trade. Furthermore, investment banks also assist clients in structuring complex transactions, getting remunerated through the spread and commissions in the process.

　　Principal Investment

　　This business refers to investment banks using proprietary funds and clients?funds to co-invest opportunistically to build a portfolio of investments defined by each firm. Investment banks usually leverage on their network of relationships with companies, investors, entrepreneurs and financial intermediaries to source potential investment opportunities. Principal investment activities often generate business for other areas of the firm, including underwriting, leveraged and other financing, and mergers and acquisitions advisory fees. Merchant banking activities generate several streams of revenue:

　　1.Management fee. Generally a percentage of a fund’s committed capital, invested capital or asset value, this form of fee revenue is recurring in nature and bear huge significance to the investment bank;

　　2.Performance fee. Typically 20% of the capital appreciation of the fund’s investment; and

　　3.The investment bank’s proportionate share of the funds?unrealized appreciation or depreciation arising from changes in fair value, as well as gains and losses upon realization.

　　Investment Management

　　Investment Management business provides a steady stream of recurring fee income to financial institutions. This “steady?revenue stream is often being valued higher than commissions, trading profits and other non-recurring income by the stock market. From the perspective of Universal banks and investment banks, they have retail and institutional distribution capabilities; naturally it would make more sense to distribute in-house fund products. For independent or dedicated fund management companies, most of them will pay a sales commission to intermediaries such as banks and insurance companies for distributing their products.

　　The key selling points for fund managers are past performance record, investment process and risk management ability. With the unusually high market volatility that we have experienced in recent years; hefty upfront sales charge (3.5% to 5%) and the wide range of choices of fund products available in the market place, investor clients have become discerning in choosing mutual fund products offered by banks and investment management firms. Below is a list of key differentiating factors for fund managers:

　　1. The portfolio construction process.

　　2. An effective portfolio monitoring process.

　　3. The investment decision making process, including the key invest ment managers and their track record.

　　4. The risk management process.

　　5. Attractive investment profiles and strategies/model portfolios/specific sector capabilities.

　　6. A long-term performance track record.

　　As investment banks seek to diversify their earnings base, the stable fee annuity derived from asset management is an attractive income stream to even out the volatile earnings from the other businesses such as equity and fixed income trading. These asset management divisions, managing funds for major institutions such as insurance, corporate and pension funds, can spin off their more successful strategies with good track record into funds for the investing public.

　　As the investment public became more sophisticated, investing style is playing a more significant role to attract new funds. The following describes two of the major investing styles:

　　1. Value investing

　　These are fund managers whose investment decisions are based on thorough fundamental research on companies. They hold the belief that having superior knowledge of the companies leads to better investment decision. Capital International is one such example in the category. Value investing style usually selects stocks using a bottom-up approach that is expected to out-perform its peer group. They look for undervalued stocks that have taken a beating due to a variety of reasons such as over-reaction to impending legislation, negative news or temporary mishaps. The nature of value investing often requires more patience but tends to be less volatile than the overall market.

　　2. Growth investing

　　Fund managers of the growth investing style look for companies with projections of substantial and consistent earning growth over the next several quarters or several years. The growth rates of these companies are typical higher than the overall market and their respective peers in the industry. However, this growth does not come cheaply. Many of these companies trade at premium P/E ratio compared to the overall market. “P/E to growth rate?multiple is a common valuation parameter used in growth investing approach.

　　Volatility characterizes the growth investors?journey. Because a growth stock’s value is based on continuing expected growth, a negative earnings surprise may caused the stock price to suffer dramatically.Alternative investments

　　Alternative Investments

　　Alternative investments such as hedge funds, real estate, commodities and private equity funds are considered separate asset classes. Under proper selection process, fund managers are known to deploy the uncorrelated characteristics of this class of assets to their asset allocation strategy.

　　Securities Services

　　Securities Lending

　　This business principally involves the borrowing and lending of equity securities to cover customers?and proprietary trading’s short positions, as well as to finance long positions. This business also includes lending to the broker-to-broker market. Lenders of securities include pension plan sponsors, mutual funds, insurance companies, investment advisors, endowments, bank trust department and individuals.

　　Prime Brokerage Services

　　This business allows the clients the flexibility to trade with most brokers while maintaining a single source for financing, settlement and portfolio reporting. This has become a hugely successful business in Wall Street given several factors:

　　1.The dramatic growth of mutual fund industry where fund management firms¡¯back-office infrastructure could no longer cope with the huge increase in volume

　　2.The proliferation of hedge funds in the U.S. has expanded the markets and the variety of securities instruments. Most hedge funds gather investment funds from sophisticated wealthy individual investors and institutional investment, unlike that of traditional mutual funds. These hedge fund operators are generally small in infrastructure, and they typically out-source the back-office activities, including trade confirmation, clearing and settlement, as well as statement and reporting.Leading players in prime brokerage services could provide multi-product clearing and custody for more than 50 countries. Financing through margin loans collateralized by securities held in client¡¯s account is also a major business of most investment banks.

　　According to the Hedgeworld Annual Compendium 2002, Morgan Stanley, Bear Sterns and Goldman Sachs are the top three prime brokers.