Investment Banking

Raising Funds by using the Investment Markets

Investment banks are banks, or divisions of banks, that help businesses or governments raise money by using the investment markets. 

When an institution needs to raise money by issuing stocks or bonds, then an investment bank will advise them and help them through the process. They will also underwrite and distribute (find buyers for) the issue. 

Investment banks also help companies that want to merge or takeover another business. They sell securities to investors and may also provide a wide range of other services such as asset management (managing a client's investments) and private wealth management (customised investment and financial planning for wealthy clients).

 

Main points about Investment Banks:

Investment banks help companies, governments and other public institutions use the investment markets, to raise capital needed for new projects and ongoing operations, by issuing or trading securities (shares and bonds).
Investment banks deal mainly with large organisations, other investment banks and institutional investors. They do not deal with the general public. They tend to be found in large cities such as London and New York.
When these clients need to raise money (capital), they can hire an investment bank to advise them. The bank will determine the amount of funding required and how this is structured, i.e. how much equity (shares) or debt (bonds).
 Investment banks advise companies when they want to raise capital by floating the company on the stock exchange (known as an Inital Public Offering). They determine the number and value of the shares to be issued and distribute and time the release of this new stock.
Investment banks will also assist companies with secondary share issues and help companies, governments and other public institutions to raise capital by issuing debt (bonds); they will help with distributing the new securities, usually to other banks and institutional investors.
Investment banks not only help with the issuing of shares and bonds but also will underwrite the new securities issued by their clients, for a fee: that means they agree to purchase the securities if they fail to sell. For very large issues, several investment banks may work together, with one being the lead underwriter.
Some investment banks are also involved in private equity. This is finding buyers for private share offerings. Companies that are in private ownership, i.e. are not floated on the stock exchange, may wish to raise capital to expand or even to take a public company, or part of it, back into private ownership.
Other key areas which investment banks undertake are mergers and acquisitions (M&A). They are involved in setting up deals and advising the world's largest organisations when they want to merge or take over another business.
M&A is an important source of income for many investment banks. Even in a recession, strategic mergers continue to happen and banks that specialise in M&A continue to do deals, although at a lower volume.
In recent years, investment banks have also been increasingly involved in management buy-outs. When these require a high level of borrowing, they are known as leverage buy-outs (LBOs). The banks will advise on the process and help with raising the funding, sometimes even taking their own investment stake (known as merchant banking).
Investment banks also trade stocks, bonds, derivatives (futures and options) and currencies with commercial banks and large institutional investors, on the secondary markets. They make money by buying securities and other commodities as cheaply as possible and then selling them on for as much money as possible.
Investment banks also advise clients about buying stocks, bonds and other securities. For larger clients, they will also manage their investments and invest on their behalf. This is known as asset management.
In recent years some banks have moved into other areas, such as investing pension contributions on behalf of companies (more usually associated with institutional investors) and private wealth management, that is advising wealthy individuals on managing and maintaining their wealth.
Investment banks make their money by charging fees for their advice and by trading securities and other financial instruments.  
 
 

Role of Investment Banks in Trading

One of a large investment bank's primary functions is the buying and selling of financial products.

Investment banks are involved in trading in two main ways. Firstly in proprietary trading, that is trading on the bank's own behalf, putting the banks own capital at risk in doing so; and, secondly, by trading on behalf of its clients.

Traders in investment banks aim to make money on each trade. They do this by buying securities and other financial instruments at a lower price than the price at which they sell them to investors, or by selling them to investors at a higher price than they buy them back. This way they can make money in both rising or falling markets. Being prepared to both buy and sell a particular security is known as market making.

Proprietary trading is performed by a special set of traders who do not interface with clients. If a trader gets it wrong, they could lose vast amounts of money, but if it goes well, they can make huge amounts of money.

The risk department of an investment bank considers the risks traders are taking and external regulators set risk limits against the capital that the bank holds. 

Investment banks also advise clients about buying stocks, bonds and other securities. Sales staff will call on institutional investors, corporations and wealthy investors to suggest trading ideas and take orders. These are then passed to the trading desk which will price the requirements and make the trades. Where appropriate, they will also structure new products that fit a specific need.

Another service a bank offers for larger investors is 'asset management'. This is when a bank manages a client's investments and invests on their behalf. Asset management gives clients access to a wider range of product offerings than would be available to the average investor.

Investment banks have created a broad array of investment products to go along with traditional stocks and bonds. They use derivatives (futures and options) to create complex structured products which usually offer much greater margins and returns than the underlying securities.

Although investment banks do not normally deal with individuals, they may offer financial planning and investment advice for individuals with high net worth (those whose liquid assets are over $1 billion).

The more money a person has, the more work it takes to maintain and preserve those assets. These high net worth individuals have a lot in common with institutional investors. Because of their wealth, they have the means to access a larger variety of conventional and alternative investments than normal investors.

Services are customised for the individuals and, typically, include advice for trusts, real estate and businesses, as well as general stock investing. This is known as private wealth management.