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Investment bank

From Academic Kids

Investment banks assist public and private corporations in raising funds in the Capital Markets (both equity and debt), as well as in providing strategic advisory services for mergers, acquisitions and other types of financial transactions. Investment banks differ from Commercial Banks which serve to directly take deposits and make commercial and retail loans. In recent years, however, the lines between the two types of structures has blurred especially as commercial banks have offered more investment banking services. The Glass-Steagall Act, initially created in the wake of the 1929 market crash, was repealed by the Gramm-Leach-Bliley Act in 1999. Glass-Steagall prohibited banks from both accepting deposits and underwriting securities. Investment banks may also differ from brokerages, which in general assist in the purchase and sale of stocks, bonds, and mutual funds. In some cases, brokerages and investment banks are integrated into single firms.

Contents

Role of Modern Investment Banks

The original purpose of an investment bank to raise capital and advise on mergers and acquisitions and other corporate financial strategies. As banking firms have diversified, investment banks have come to fill a variety of roles (list taken from the Swiss Banking Institute (http://faculty-staff.ou.edu/M/William.L.Megginson-1/ib.pdf):

  • Underwriting and distributing new security issues
  • Offering brokerage services to public & institutional investors
  • Providing financial advice to corporate clients, especially on security issues, M&A deals
  • Providing financial security research to investors and corporate customers
  • Market-Making in particular securities

Investment banks have also moved into foreign currency exchange, private banking, and bridge financing.

How Investment Banks Raise Money

A key role of investment banks is to advise companies in raising money. There are two varieties of 'fund' raising which investment bankers typically engage in: raising funds through the capital markets and through private placements. Investment bankers can raise funds in capital markets in two ways. They can sell the company's equities in the stock market in an initial public offering (IPO) or secondary offering, or they can advise on debt issues to the public markets. These sales are tightly regulated by governing bodies such as the Securities and Exchange Commission in the United States, the largest such regulating body in the world.

Investment bankers also advise companies on private placements. These are the purchase or sale of corporate securities by private companies or individual. Types of private placement transactions include venture capital investments, strategic investments by companies, private equity investments, private debt placements, acquisitions, divestitures, and merchant banking. Investment bankers create value for their clients through three primary means: They possess an extensive network of industry and financial contacts, they create a competitive environment for the company's securities, and they possess current market knowledge about transaction structuring, legal processes and comparable market events.

The main activities and units

Large, global investment banks typically have several business units, including Corporate Finance, concerned with advising on the finances of corporations, including mergers, acquisitions and divestitures; Research, concerned with investigating, valuing, and making recommendations to clients - both individual investors and larger entities such as hedge funds and mutual funds - regarding shares and corporate and government bonds); and Sales and Trading, concerned with buying and selling shares both on behalf of the bank's clients and also for the bank itself. Management of the bank's own capital, or Proprietary Trading, is often one of the biggest sources of profit. For example, the banks may arbitrage stock on a large scale if they see a suitable profit opportunity or they may structure their books so that they profit from a fall in bond price or yields. The individual activities are described below:

Corporate Finance, is the traditional aspect of investment banking which involves helping customers raise funds in the Capital Market and advising on mergers and acquisitions. Generally the highest profit margins come from advising on mergers and acquisitions. Investment Bankers have had a palpable effect on the history of American business, as they often proactively meet with executives to encourage deals or expansion.

Research, is the division which reviews companies and writes reports about their prospects, often with "buy" or "sell" ratings. Although in theory this activity would make the most sense at a stock brokerage where the advice could be given to the brokerage's customers, in fact Research has historically been performed by Investment Banks. The primary reason for this is because the Investment Bank must take responsibility for the quality of the company that they are underwriting vis a vis the prices involved to the investor.

Sales and Trading, is often the the most profitable area of an investment bank, usually responsible for a much larger amount of revenue than the other divisions. In the process of market making, investment banks will buy and sell stocks and bonds with the goal of making an incremental amount of money on each trade. Sales is the term for the investment banks sales force, who's primary job is to call on institutional investors to buy the stocks and bonds underwritten by the firm. Another activity of the sales force is to call institutional investors to sell stocks, bonds, commodities, or other things the firm might have on its books. These calls are on a caveat emptor basis.

Possible conflicts of interest

Because potential conflicts of interest may arise between different parts of a bank, the authorities that regulate investment banking (the FSA in the United Kingdom and the SEC in the United States) require that banks impose a Chinese wall which prohibits communication between Investment Banking on one side and Research and Equities on the other.

These are some of the conflicts of interest involved in investment banking:

  • Historically, most equity research firms are owned by investment banks. It is common practice for equity analysts to initiate coverage on a company in order to develop a relationship with that company that will lead to highly profitable investment banking business. In the 1990s, many equity researchers allegedly traded positive stock ratings directly for investment banking business. The practice went the other way as well: companies would threaten to divert investment banking business to competitors unless an analyst rated their stock favorably. No one is sure how widespread these criminal acts were. Increased pressure from regulators and a series of lawsuits, settlements, and prosecutions curbed this business to a large extent following the 2001 stock market crash.
  • Many investment banks also own retail brokerages. Also during the 1990s, some retail brokerages sold consumers securities which did not meet their stated risk profile. This behavior allegedly occurred, much like with equity researchers, to clinch investment banking business or even to sell surplus shares during a public offering to keep public perception of the stock favorable.

Investment banks

Some of the major global public and private investment banks include:

See also

fr:banque d'investissement zh:投资银行

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