Corporate Finance (equity)
Corporate Finance (debt)
Mergers & Acquisitions (M&A)
Fixed Income Sales
Fixed Income Trading
Fixed Income Research
The functions of all of these areas will be discussed in much more detail later in the book. In this overview section, we will cover the nuts and bolts of the business, providing an overview of the stock and bond markets, and how an I-bank operates within them.
The bread and butter of a traditional investment bank, corporate finance generally performs two different functions: 1) Mergers and acquisitions advisory and 2) Underwriting. On the mergers and acquisitions (M&A) advising side of corporate finance, bankers assist in negotiating and structuring a merger between two companies. If, for example, a company wants to buy another firm, then an investment bank will help finalize the purchase price, structure the deal, and generally ensure a smooth transaction. The underwriting function within corporate finance involves shepherding the process of raising capital for a company. In the investment banking world, capital can be raised by selling either stocks or bonds (as well as some more exotic securities) to investors.
Sales is another core component of any investment bank. Salespeople take the form of: 1) the classic retail broker, 2) the institutional salesperson, or 3) the private client service representative. Retail brokers develop relationships with individual investors and sell stocks and stock advice to the average Joe. Institutional salespeople develop business relationships with large institutional investors. Institutional investors are those who manage large groups of assets, for example pension funds, mutual funds, or large corporations. Private Client Service (PCS) representatives lie somewhere between retail brokers and institutional salespeople, providing brokerage and money management services for extremely wealthy individuals. Salespeople make money through commissions on trades made through their firms or, increasingly, as a percentage of their clients' assets with the firm.
Traders also provide a vital role for the investment bank. In general, traders facilitate the buying and selling of stocks, bonds, and other securities such as currencies and futures, either by carrying an inventory of securities for sale or by executing a given trade for a client.
A trader plays two distinct roles for an investment bank:
(1) Providing liquidity: Traders provide liquidity to the firm's clients (that is, providing clients with the ability to buy or sell a security on demand). Traders so this by standing ready to immediately buy the client's securities (for sell securities to the client) if the client needs to place a trade quickly. This is also called making a market, or acting as a market maker. Traders performing this function make money for the firm by selling securities at a slightly higher price than they pay for them. This price differential is known as the bid-ask spread. (The bid price at any given time is the price at which customers can sell a security, which is usually slightly lower than the ask price, which is the price at which customers can buy the same security.)
(2) Proprietary trading: In addition to providing liquidity and executing traders for the firm's customers, traders also may take their own trading positions on behalf of the firm, using the firm's capital hoping to benefit from the rise or fall in the price of securities. This is called proprietary trading. Typically, the marketing-making function and the proprietary trading function is performed by the same trader for any given security. For example, Morgan Stanley's Five Year Treasury Note trader will typically both make a market in the 5-Year Note as well as take trading positions in the 5-Year Note for Morgan Stanley's own account.
Research analysts follow stocks and bonds and make recommendations on whether to buy, sell, or hold those securities. They also forecast companies' future earnings. Stock analysts (known as equity analysts) typically focus on one industry and will cover up to 20 companies' stocks at any given time. Some research analysts work on the fixed income side and will cover a particular segment, such as a particular industry's high yield bonds. Salespeople within the I-bank utilize research published by analysts to convince their clients to buy or sell securities through their firm. Corporate finance bankers rely on research analysts to be experts in the industry in which they are working. Reputable research analysts can generate substantial corporate finance business for their firm as well as substantial trading activity, and thus are an integral part of any investment bank.
The hub of the investment banking wheel, the syndicate group provides a vital link between salespeople and corporate finance. Syndicate exists to facilitate the placing of securities in a public offering, a knock-down drag-out affair between and among buyers of offerings and the investment banks managing the process. In a corporate or municipal debt deal, syndicate also determines the allocation of bonds.
Generally, the breakdown of an investment bank includes the following areas: