About Investment Banking

Investment Banking vs. Commercial Banking

Traditionally, the term Investment banking or I-banking is used to describe the business of raising capital for companies and advising them on financing and merger alternatives. In order to raise this cash, investment banks sell securities of stocks and bonds to investors, which will later be traded in global financial markets. Commercial banking in contrary, loans your deposit money to consumers and companies in need for capital. Today however, the traditional lines and culture of commercial banking and investment banking are blurring, as the laws requiring the separation of investment banking and commercial banking are reformed and synergies are gained.

However, investment banking is not one specific service or function, but rather encompasses a range of functions. Reporting on all investment bank activities is beyond the scope of this short introduction, but a brief description will follow.

Capital Markets

The capital markets division, which is often split in equity capital markets and debt capital markets, is involved with the traditional business of investment banking which is raising either debt or equity capital for firms. Investment banks underwrite and distribute new issues of debt and equity for these firms. New equity issues include primary, the initial offerings of companies (IPOs), or secondary issues (Seasoned Equity Offerings). Debt underwriting involves new issues of debt such as bonds. Securities underwritings can be undertaken through either public offerings or private offerings. In a private offering, the investment banker acts as a private placement agent for a fee, placing the securities with one or a few large institutions. In a public offering, the securities may be underwritten on a best-efforts or a firm commitment basis, and the securities may be offered to the public at large. In firm commitment underwriting, the investment banker acts as a principal, purchasing the securities from the issuer at one price and seeking to place them with public investors at a slightly higher price.

M&A Advisory

Investment banks provide advice and assist in mergers and acquisitions. They can for example, assist in finding merger partners, underwriting new securities to be issued by the merged firms, assessing the value of target firms, recommending terms of the merger agreement, and even helping target firms to prevent a merger. Setting up deals where one company buys another is an important source of fee income for many investment banks; it has been a hot area on Wall Street in the 1990s and is likely to continue through the next century.

Sales and trading

Instead of creating a primary market in securities like the capital market divisions, sales and trading divisions of investment banks create a secondary market for securities. Sales and trading, which can also be called market making, can involve either agency or principal transactions. Agency transactions are two-way transactions on behalf of customers, for example, acting as a stockbroker or dealer for a fee or commission. In principal transactions, the market maker seeks to profit from price movements of securities and take either long or short positions for its own account. There are many types of trading, among which for example position trading, meaning purchasing a large block of securities on the expectation of a favorable price move. Pure arbitrage trading entails buying one asset at one price and selling it immediately in another market at a higher price. Risk arbitrage involves buying blocks of securities in anticipation of some information release, such as a merger or takeover announcement or a Federal Reserve interest rate announcement.

Asset management

Asset management is the professional management of securities and other assets (real estate, etc.) on behalf of clients. That may be institutions (insurance companies, pension funds, corporations, etc.), or private investors (individuals or groups of individuals, such as mutual funds). The Asset Management division is sometimes called Investment Management. The provision of 'investment management services' includes elements of financial analysis, asset selection, stock selection, plan implementation and ongoing monitoring of investments. Investment management is a large and important global industry in its own right responsible for caretaking of trillions of dollars, euros, pounds and yen. Coming under the remit of financial services many of the world's largest companies are at least in part investment managers and employ thousands of staff and create billions in revenue.

Equity and fixed income research

Research is the division which reviews companies and writes reports about their prospects, often with "buy" or "sell" ratings. While the research division generates no revenue, its resources are used to assist traders in trading, the sales force in suggesting ideas to customers, and investment bankers in covering their clients. There is a potential conflict of interest between the investment bank and its analysis in that published analysis can affect the profits of the bank. Therefore in recent years the relationship between investment banking and research has become highly regulated requiring a Chinese wall between public and private functions.

Merchant Banking

Although not defined in U.S. federal banking and securities laws, the term merchant banking is generally understood to mean negotiated private equity investment by financial institutions in the unregistered securities of either privately or publicly held companies. Both investment banks and commercial banks engage in merchant banking, and the type of security in which they most commonly invest is common stock. They also invest in securities with an equity participation feature; this may be convertible preferred stock or subordinated debt with conversion privileges or warrants. Other investment bank services - raising capital from outside sources, advising on mergers and acquisitions, and providing bridge loans while bond financing is being raised in a leveraged buyout (LBO) - are also typically offered by financial institutions engaged in merchant banking.