Capital Markets and Investment Banking Process
The investment environment is vast and can be overwhelming if not entered into correctly. Firm’s issuing new securities to enhance revenues understand the complexities and risks involved when entering the primary market, and will employ investment bankers to mitigate those risks. Described throughout this paper is the investment banking process and portfolio construction, factors for selecting the portfolio asset classes, the capital market instruments used in portfolio construction, and recommendations for the composition of an investment portfolio.
Investment Banking Process and Portfolio Construction
Investment bankers work with firms issuing new securities as both an advisor and intermediary in setting security prices, interest rates, and marketing the new securities for sale in the primary market (Bodie, Kane, & Marcus, 2008). The primary market is where firms are able to sell their new securities and obtain funds that are needed to increase their capital base. Firms issuing new securities are strategically working to raise funds; however, there is a potential risk that all the newly issued securities will not sell and the strategy to raise funds could fail. To mitigate this potential risk firms hire an investment banker as an underwriter.
As an underwriter the investment banker assumes the risks by purchasing the firms new securities at a fixed price lower than the offering price to the public, and then sells the securities at the current market price for a profit (Hirt & Block, 2008). “With underwriting, once the security is sold, the investment banker will usually make a market in the security, which means active buying and selling to ensure a continuously liquid market and wider distribution” (Hirt & Block, 2008, P. 27).
After the investment banker has sold the new securities issued by a firm in the primary market, those securities then become an existing asset that is traded in the secondary market between investors (Hirt & Block, 2008). In the secondary market investors buy and sell the different existing assets which allow the market to operate efficiently, competitively, continually, and liquidity. Investors investing in these existing assets create a portfolio to monitor their current investment assets, and make their investment decisions based on their portfolio size (Bodie, Kane, & Marcus, 2008).
In the construction of a “top-down” portfolio the first step is asset allocation. “The process of building an investment portfolio usually begins by deciding how much money to allocate to broad classes of assets, such as safe money-market securities or bank accounts, longer-term bonds, stocks, or even asset classes such as real estate or precious metals” (Bodie, Kane, & Marcus, 2008, P. 24). Once the asset class allocation has been determined by the investor the next step in the process is to select which securities to purchase. Once a security in an asset class is decided on an investor may perform a valuation through a security analysis. The security analysis will aid the investor’s decision by estimating the securities value and the positive or negative impact on the portfolio (Bodie, Kane, & Marcus, 2008).
Factors among asset classes in an investment portfolio
During the asset allocation process in an investment portfolio there are different factors that must be considered by the investor before an asset class is decided upon. The three factors important to investors when creating an investment portfolio and conducting the asset allocation process is: their investing goals, their investing time horizon, and their level of risk tolerance (Investor Guide, 2010).
When considering the factor of investing goals during the asset allocation the investor is determining both long- and short-term goals in terms of income, or return, requirements. When considering this factor an investor is able to...