Science Fair Project Encyclopedia
Investment banks assist corporations in raising funds in the public markets (both equity and debt), as well as provide strategic advisory services for mergers, acquisitions and other types of transactions. Over time, and especially the past decade, many investment banks have come to offer a wider range of services than just raising capital and advising large corporations.
Investment banks technically differ from Commercial Banks which serve to directly take deposits and make loans. In recent years, however, it has been increasingly common to see commerical banks and investment banks combined together, as banks have become more integrated. The Glass-Steagall Act was repealed by the Gramm-Leach-Bliley Act in 1999, in the United States, the Glass-Steagall Act prohibited banks from offering both commercial and investment services.
Investment banks also technically differ from brokerages, which are firms which assist people in choosing and buying stocks, bonds, and mutual funds. In many cases, brokerages and investment banks are integrated into single firms, and some brokerage companies also do investment banking and some investment banks also do some brokerage.
Role of Modern Investment Banks
The original purpose of investment banks was primarily raising capital and advising on mergers and acquisitions. As banking firms have diversified, investment banks have come to fill a variety of roles (list taken from the Swiss Banking Institute (pdf):
- Underwriting and distributing new security issues
- Offering brokerage services to public & institutional investors
- Providing financial advice to corporate clients, especially on security issues, M&A deals
- Providing financial security research to investors and corporate customers
- Market-Making in particular securities
Investment banks have also moved into foreign currency exchanges, private banking, and providing bridge loans.
How Investment Banks Raise Money
A key role of investment banks is to advise companies in raising money. There are two types of fundraising investment bankers typically engage in: fundraising in capital markets and private placements .
Investment bankers can raise funds in capital markets in two ways. They can sell the company's equities in the stock market in an initial public offering (IPO) or secondary offering, or they can advise on debt issues to the public markets. These sales are tightly regulated by governing bodies such as the Securities and Exchange Commission in the United States, the largest such regulating body in the world.
Investment bankers also advise companies on private placements . These are the purchase or sale of corporate assets by private companies or individual. Types of private placement transactions include venture capital investments, strategic investments by companies, private equity investments , acquisitions, divestitures, merchant banking, and more.
Investment bankers create value for their clients through three primary means: They possess an extensive network of industry and financial contacts, they create a competitive environment for the company's securities, and they possess current knowledge about matters such as transaction structuring, legal processes, and comparable market events.
The main activities and units
Large, global investment banks typically have several business units, including Corporate Finance (concerned with managing the finances of corporations, including mergers, acquisitions and disposals), often called the Investment Banking Division of the firm; Research (concerned with investigating, valuing, and making recommendations to clients--both individual investors and larger entities such as hedge funds and mutual funds--regarding shares and corporate and government bonds); and Sales and Trading (concerned with buying and selling shares both on behalf of the bank's clients and sometimes also for the bank itself). Management of the bank's own capital, or Proprietary Trading, is often one of the biggest sources of profit; for example the banks may arbitrage in huge scale if they see a suitable opportunity and/or they may structure their books so that they profit from a fall of bond yields (a rise of bond prices). Each activity is described below:
Corporate Finance, is the traditional aspect of investment banking which involves helping customers raise funds in the capital markets and advising on things such as mergers and aquisitions. Employees in this area are the stereotypical investment bankers, who are generally noted for their high pay and jet setting lifestyle. Famous corporate finance investment bankers include Michael Milken. Generally the highest profit margins come from advising on mergers and aquisitions. Investment Bankers have a palpable effect on the history of American business, as they often proactively meet with executives to encourage deals or expansion.
Research, is the division which reviews companies and writes reports about their prospects, often with "buy" or "sell" ratings. Although in theory this activity would make the most sense to occour at a stock brokerage, where the advice could be given to the brokerage's customers, in fact Research has historically been performed by Investment banks (even though they may not have any brokerage customers). One of the primary reasons for this is for many years research reports had an allegedly unethical purpose of giving positive reviews to the investment banks current or prospective corporate finance clients. This conflict of interest resulted in a large amount of fines being paid in a global settlement.
Sales and Trading, is often the the most profitable area of an investment bank, usually responsible for a much larger amount of revenue then the other divisions. In the process of market making, investment banks will buy and sell stocks and bonds with the goal of making an incremental amount of money on each trade. Sales is the term for the investment banks sales force, who's primary job is to call on insitutional investors to buy the stocks and bonds underwritten by the firm. Another activity of the sales force is to call institutional investors to sell stocks, bonds, commodities, or other things the firm might have on its books. These calls are on a caveat emptor basis.
Possible conflicts of interest
Because potential conflicts of interest may arise between different parts of a bank, the authorities that regulate investment banking (the FSA in the United Kingdom and the SEC in the United States) require that banks impose a Chinese wall which prohibits communication between Investment Banking on one side and Research and Equities on the other.
These are some of the conflicts of interest involved in investment banking:
- Historically, most equity research firms are owned by investment banks. It is common practice for equity analysts to initiate coverage on a company in order to develop a relationship with that company that will lead to highly profitable investment banking business. In the 1990s, many equity researchers allegedly traded positive stock ratings directly for investment banking business. The practice went the other way as well: companies would threaten to divert investment banking business to competitors unless an analyst rated their stock favorably. No one is sure how widespread these criminal acts were. Increased pressure from regulators and a series of lawsuits, settlements, and prosecutions curbed this business to a large extent following the 2001 stock market crash.
- Many investment banks also own retail brokerages . Also during the 1990s, some retail brokerages sold consumers securities which did not meet their stated risk profile. This behavior allegedly occurred, much like with equity researchers, to clinch investment banking business or even to sell surplus shares during a public offering to keep public perception of the stock favorable.
Some of the major global public and private investment banks include:
- ABN Amro
- Banc of America Securities
- Barclays Capital
- Bear Stearns
- BNP Paribas
- Brown Brothers Harriman
- Credit Suisse First Boston
- Deutsche Bank
- Dresdner Kleinwort Wasserstein
- Goldman Sachs
- Jefferies & Co.
- JPMorgan Chase
- Lehman Brothers
- Merrill Lynch
- Morgan Stanley
- SG Cowen
- Thomas Weisel Partners
- UBS AG
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