What is an Investment Bank?

by Derek Loosvelt | March 10, 2009

What is investment banking? Is it investing? Is it banking? Really, it is neither. Investment banking, or I-banking, as it is often called, is the term used to describe the business of raising capital for companies. Capital essentially means cash or money. Companies need cash in order to grow and expand their businesses; investment banks sell securities to public investors in order to raise this cash. These securities can come in the form of stocks or bonds.

Generally, the breakdown of an investment bank includes the following areas:

Corporate Finance

The bread and butter of any 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 Corp Fin (as corporate finance is often called) involves shepherding the process of raising capital for a company. In the investment banking world, capital can be raised by either selling stocks or bonds to investors.

Sales

Sales is truly the heart 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. 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 or mutual funds. 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.

~Trading

Traders provide a vital but less glamorous role for the investment bank. Traders facilitate the buying and selling of stock, bonds, or other securities such as currencies, either by carrying an "inventory" of securities for sale or by executing a given trade for a client. Traders deal with transactions large and small and provide "liquidity" (the ability to buy and sell securities) for the market. (This is often called "making markets.") Traders make money by purchasing securities and selling them at a slightly higher price. This price differential is called the "bid-ask spread."

Research

Research analysts follow stocks and bonds and make recommendations on whether to buy, sell, or hold those securities. 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 high-yield bonds or U.S. Treasury 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 as well as substantial trading activity, and thus are an integral part of any investment bank.

Syndicate

The hub of the investment banking wheel, syndicate provides a vital link between salespeople and corporate finance. Syndicate exists to facilitate the placing of stock in any 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.

Filed Under: Finance


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