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by Derek Loosvelt | September 09, 2002

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Good? Bad? I'm the guy with the stocks

Tom Wolfe called them "Masters of the Universe" in The Bonfire of the Vanities; Michael Lewis called them a few unprintable things in Liar's Poker. To the rest of the world, they are investment bankers, salespeople and traders. Investment banks aren't your local branch offices with their ubiquitous ATMs (those are commercial banks, like Citibank or Bank of America); instead, investment banks work with corporations, governments, institutional investors and extraordinarily wealthy individuals to raise capital and provide investment advice.

What is investment banking?

For starters, investment banking is neither investing nor banking. I-banking, as it is often called, is the term used to describe the business of raising capital for companies. Capital in this sense means cash or money; when firms need cash in order to grow and expand their businesses, I-banks sell securities to public investors in order to raise this cash.

End of act; curtain falls

The casual observer can be forgiven for confusion over just what constitutes an investment bank. The distinction used to be much clearer, thanks to the legal barrier between commercial and investment banks erected by the Glass-Steagall Act of 1933. This act, passed in the wake of the stock market crash that began the Great Depression, was intended to rebuild confidence in the United States' (and the world's) shattered banking system, as well as to protect customers' deposits from market speculation. This policy has been rapidly decaying since the 1980s. Firms like Germany's Deutsche Bank have been spending enormous amounts of money to establish their own investment banking arms, while other commercial banks have been acquiring small- to medium-sized investment banks at a rapid rate.

Corporate finance

As one of the linchpins of any traditional investment bank, corporate finance generally performs two different functions: mergers and acquisitions advisory and underwriting. On the mergers and acquisitions (M&A) 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, 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 it is often called) involves shepherding the process of raising capital for a company. In the investment-banking world, capital is raised by selling either stocks or bonds to investors.

Sales

The sales unit is another crucial part of any investment bank. Salespeople take the form of either the classic "retail broker" or the institutional salesperson. Brokers develop relationships with individual investors, selling stocks and stock advice to customers. Institutional salespeople develop business relationships with large institutional investors, such as money managers, pension fund managers or mutual fund companies. Private Client Service (PCS) representatives lie somewhere between retail brokers and institutional salespeople, providing brokerage and money management services for very wealthy individuals. Salespeople make money through commissions on trades made through their firm.

Trading

Traders provide a vital but less glamorous role for the investment bank. They facilitate the buying and selling of stock, either by carrying an "inventory" of securities for sale or by executing a given trade for a client. Traders deal with transactions of all sizes and provide "liquidity" (the ability to buy and sell securities) for the market. The money comes from purchasing securities and selling them at a slightly higher price. This price differential is called the "bid-ask spread."

Research

Research analysts follow either stocks or fixed income securities. Analysts that follow stocks make recommendations on whether to buy, sell, or hold those stocks. Analysts typically focus on one industry and will "cover" up to 20 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 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.

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Filed Under: Finance

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