An investment bank is a financial intermediary that primarily provides the following services:
- Raising Capital and Underwriting Security
- Acquisitions and mergers
- Trading and Sales
- Commercial and retail banking
Investment banks make money by charging fees and commissions for these and other financial and business advisory services.
Stocks and bonds are examples of securities, and a stock offering might be an initial stock offering (IPO). The technique by which an underwriter introduces a new security issue to the investing public in an offering is known as underwriting. The underwriter guarantees the company (client) issuing the security a specific price for a specific quantity of securities (in exchange for a fee). As a result, the issuer is assured of raising a specified minimum amount from the offering, while the underwriter bears the risk of the offering.
Before we get started… Get the IB Salary Guide.
Raising Capital and Underwriting Security
Investment banks act as intermediaries between a corporation seeking to issue new securities and the general public interested in purchasing them. An investment bank is hired by a corporation when it needs to issue new bonds, for example, to raise funds to repay an earlier bond or pay for an acquisition or new project. The investment bank then assesses the business’s value and risk before pricing, underwriting, and selling the new bonds. Other securities (such as stocks) are also underwritten by banks through an initial public offering (IPO) or any subsequent secondary (vs. initial) public offering. When an investment bank underwrites a stock or bond offering, it assures that the buying public – usually institutional investors such as mutual funds or pension funds – commits to acquiring the issue before it goes public. In this sense, investment banks act as middlemen between securities issuers and the general public. Several investment banks will buy the new issuance of securities from the issuing firm for an agreed price and promote the securities to investors in a procedure known as a roadshow. The company keeps the new cash, while the investment banks form a syndicate (a group of banks) and resell the issue to their customers (mostly institutional investors) and the general public. Investment.
M&A advice and other company restructuring
The word “mergers and acquisitions,” or M&A, is certainly familiar to you. Because the fee margin structure is far greater than most underwriting fees, it’s a significant source of fee income for investment banks. This is why M&A bankers are among the most well-paid and well-known in the industry. M&A advising became an increasingly successful line of business for investment banks as a result of substantial corporate consolidation throughout the 1990s. M&A is a cyclical industry that was severely harmed during the financial crisis of 2008-2009, recovered in 2010, and then fell again in 2011. In any case, M&A will almost certainly remain a key priority for investment banks. Morgan Stanley, JP Morgan, Goldman Sachs
Investment banks’ M&A consulting services often cover many areas of the acquisition and sale of firms and assets, including business valuation, negotiation, price, and transaction structuring, as well as protocol and implementation. Investment banks also issue “fairness opinions,” which are documentation that attest to the transaction’s fairness. Firms seeking M&A counsel will occasionally contact an investment bank directly with a transaction in mind, but investment banks will frequently “pitch” proposals to potential clients.
What exactly is M&A advisory work?
First, some terminology: A sell-side engagement occurs when an investment bank acts as a counsellor to a potential seller (target). When an investment bank acts as a buyer’s counsel, on the other hand,
Do Your Research
When investment banks advise a buyer (acquirer) on a potential purchase, they frequently assist with due diligence, which focuses on a target’s underlying financial picture to reduce risk and exposure to an acquiring company. Gathering, analysing, and interpreting financial information from the target, reviewing past and future financial performance, evaluating potential synergies, and examining operations to find opportunities and areas of concern are all part of due diligence. By offering risk-based investigative research and other knowledge that helps a buyer identify risks – and advantages – throughout the transaction, thorough due diligence increases the likelihood of success.
Process of Sample Merger
Weeks 1-4: Strategic Analysis of a Potential Transaction
The Investment Bank will find possible merger partners and contact them privately to explore the deal. The Investment Bank will meet with potential partners as they respond to see if the transaction makes sense. Follow-up meetings with serious potential partners to negotiate terms
- Weeks 5-6: Documentation and Negotiation
- Finalize the merger and reorganisation agreement.
- Pro forma negotiations Board of Directors and Management Personnel
- As needed, negotiate employment agreements.
- Ascertain that the transaction satisfies the requirements for a tax-free reorganisation.
- Prepare legal paperwork Negotiation Results Reflected
Week 7: Approval by the Board of Directors
The Boards of Directors of both the Client and Merger Partner meet to ratify the transaction, while the Investment Bank (and the investment bank advising the Merger Partner) both issue a Fairness Opinion attesting to the transaction’s “fairness” (i.e., nobody overpaid or underpaid, the deal is fair). All final agreements have been signed.
Weeks 8-20: Regulatory Filings and Shareholder Disclosure
Both firms prepare and file the necessary documentation (Registration Statement: S-4), as well as schedule a shareholder meeting. Prepare antitrust filings (HSR) and start putting together integration plans.
Week 21: Approval by Shareholders
To approve the merger, both firms hold shareholder meetings.
Closing Weeks 22-24
Effect share issuing and close merger and reorganisation
Trading and Sales
Investment banks are used by institutional investors such as pension funds, mutual funds, university endowments, and hedge funds to trade securities. Investment banks connect buyers and sellers, as well as buy and sell assets on their own accounts, to ease securities trading and create a market. a securities that gives investors with liquidity and prices Investment banks impose commission fees in exchange for these services. Furthermore, an investment bank’s sales and trading department supports the secondary market trading of securities guaranteed by the bank. Returning to our Gillette example, JP Morgan must find purchasers for the freshly issued shares once the new instruments have been priced and underwritten. Remember that JP Morgan has guaranteed Gillette the price and amount of the new shares, therefore JP Morgan must be confident in their ability to sell them. It is for this reason that an investment bank’s sales and trading department operates. This is an important part of the underwriting process; in order to be a good underwriter, you must be able to do this. An investment bank must be able to distribute securities efficiently. To that purpose, the investment bank’s institutional sales staff is in place to establish relationships with purchasers in order to persuade them to purchase these assets (Sales) and to execute trades efficiently (Trading).
Sales
The sales force of a company is in charge of informing institutional investors about specific securities. When a stock moves suddenly or a firm announces earnings, the investment bank’s sales staff informs the portfolio managers (“PM”) covering that particular stock on the “buy-side” (the institutional investor). In addition, the sales force is in continual contact with the firm’s traders and research analysts in order to give timely, relevant market knowledge and liquidity.
Trading
Traders are the last link in the chain, buying and selling assets on behalf of institutional clients as well as for their own business in anticipation of changing market circumstances and in response to customer requests. They manage positions in numerous sectors (traders specialise in specific types of equities, fixed income securities, derivatives, currencies, commodities, and so on…) and buy and sell securities to strengthen such positions. Traders at commercial banks, investment banks, and huge institutional investors deal with one another. Position trading, risk management, sector analysis, and capital management are some of the trading tasks.
Equity Analysis
Institutional investors have traditionally been drawn to investment banks by offering them access to equities research analysts and the chance to be first in line for “hot” IPO shares that the investment bank underwrites. As a result, research has long been an important component of share sales and trading (and represents a significant cost of the sales & trading business).
Commercial Banking and Retail Brokerage
The Glass-Steagall Act, which was in effect from 1932 to 1999, stated that commercial banks can lend money, extend lines of credit, and open checking and savings accounts, while investment banks can underwrite securities, advise on mergers and acquisitions, and provide institutional brokerage services. Commercial enterprises are protected under the Glass Stegall Act. Banks and investment banks have to limit their activities to those that were traditionally associated with those names. The removal of the Depression-era Glass-Steagall Act in late 1999 marked the beginning of financial services deregulation. Commercial banks, investment banks, insurers, and securities brokerages were now able to offer each other’s services. As a result, many investment banks now provide retail brokerage as well as commercial loans to individual investors rather than institutional clients. JP Morgan, for example, now offers checking accounts through its Chase brand, as well as investment banking and asset management services. Until 1999, it was technically illegal for one financial institution to provide all of these services under one roof (although there were numerous post-enactment loopholes). Long before 1999, the law was effectively neutered). Deregulation has had a significant impact on the financial services industry, with the repeal paving the way for mega-mergers and consolidation. Many people believe that repealing Glass-Steagall contributed to the financial crisis of 2008-9.
Investment Banking’s Background
Without a doubt, investment banking in the United States has come a long way since its inception. A brief history is provided below.
1896-1929
Prior to the Great Depression, investment banking was in its heyday, with the industry experiencing a long period of growth. Market giants JP Morgan and National City Bank frequently intervened to influence and maintain the financial system. In 1907, JP Morgan (the man) is credited with saving the country from a catastrophic panic. The market crash of 1929, which sparked the Great Depression, was caused by excessive market speculation, particularly by banks using Federal Reserve loans to prop up the markets.
1929-1970
The nation’s financial system was in shambles during the Great Depression, with 40% of banks collapsing or being forced to consolidate. The government established the Glass-Steagall Act (or more technically, the Bank Act of 1933) with the goal of rehabilitating the banking system by building a barrier between commercial and investment banking. In addition, the government sought to create a barrier between investment bankers and brokerage services in order to avoid a conflict of interest between the desire to win investment banking business and the obligation to provide fair and objective brokerage services (i.e., to prevent the sale of investment banking services). An investment bank’s temptation to intentionally peddle an overvalued client business’s securities to the investing public in order to ensure that the client firm uses the investment bank for future underwriting and advising needs). The “Chinese Wall” was the name given to the restrictions prohibiting such activity.
1970-1980
Trading commissions plummeted and trading profitability declined with the elimination of negotiated rates in 1975. The idea of an integrated investment bank, combining sales, trading, research, and investment banking under one roof, began to take root as research-focused boutiques were forced out. The growth of financial products such as derivatives, high yield, and structured products in the late 1970s and early 1980s produced profitable returns for investment banks. Investment bankers celebrated the facilitation of corporate mergers as the last gold mine in the late 1970s, assuming that Glass-Steagall would eventually fall, resulting in a securities business overrun by commercial banks. Glass-Steagall did eventually fall apart, but not until 1999. And the results weren’t nearly as bad as some had predicted.
1980-2007
Investment bankers had shed their staid image by the 1980s. It was replaced by a reputation for power and flair, which was bolstered by a flurry of mega-deals made during a period of unprecedented prosperity. Investment bankers’ activities were widely publicised, including by author Tom Wolfe in “Bonfire of the Vanities” and film director Martin Scorsese.
Oliver Stone’s social critique in “Wall Street” concentrated on investment banking. Finally, as the 1990s came to a close, an IPO boom dominated investment bankers’ perceptions. In 1999, there were 548 initial public offerings (IPOs), the most ever in a single year, with the majority of them in the internet industry. The Gramm-Leach-Bliley Act (GLBA) of November 1999 effectively removed the Glass-Steagall Act’s long-standing limits on the mixing of banking and securities or insurance companies, allowing “wide banking.” Because the barriers separating banking from other financial activity had been eroding for some time, GLBA should be considered as ratifying rather than reinventing banking practise.
Following the 2008 Financial Crisis, Investment Banking
Multiple factors, including the collapse of the subprime mortgage market, poor underwriting practises, overly complex financial instruments, as well as deregulation, poor regulation, and in some cases a complete lack of regulation, triggered the worst global financial crisis since the Great Depression in 2008. The Dodd-Frank Act, which sought to improve regulatory blind spots that contributed to the crisis by increasing capital requirements and bringing hedge funds, private equity firms, and other investment firms considered to be part of a minimally regulated “shadow banking system,” is perhaps the most significant piece of legislation to emerge from the crisis. Similar to banks, these businesses raise funds and invest, but avoided regulation, allowing them to abuse their power and create systemic contagion. The verdict on Dodd-effectiveness Frank’s is yet out, and the Act has been widely attacked by both proponents of further regulation and those who feel it would hinder growth.
Goldman Sachs and other investment banks have switched to BHCs
Historically, “pure” investment banks such as Goldman Sachs and Morgan Stanley have benefited from less government supervision and less capital requirement than their full-service counterparts such as UBS, Credit Suisse, and Citi. However, during the financial crisis, pure investment banks were forced to convert to bank holding companies (BHC) in order to receive government bailout funds. On the other hand, their BHC classification now makes them subject to increased supervision. Prospects for the Industry Following the Crisis
In 2010, worldwide investment banking advice fees reached $84 billion, the highest level since 2007. Although the official scorecard has yet to be released, public announcements from the main banking institutions indicate that costs would decrease significantly in 2011. The industry’s future is a hotly discussed matter. There is little doubt that the financial services industry is undergoing significant post-crisis changes. In 2008 and 2009, many banks suffered near-death experiences and are still struggling. Many of the world’s major financial firms saw their profits plummet in 2011. Even entry-level investment bankers’ bonuses are affected by this. Some argue that the reduced percentage of ivy league graduates going into finance is a sign of a fundamental shift. However, people looking to start into the field will discover that compensation is relatively competitive when compared to other options. Furthermore, because the work role of an M&A expert has not altered significantly, professional development prospects have not changed.
Organizational Structure of an Investment Bank
Front office, middle office, and back office are the three divisions of investment banks. Each sector is distinct, but they all contribute to the bank’s profitability, risk management, and seamless operation.
The front desk
Do you aspire to work as an investment banker? Most likely, the position you’re picturing is in the front office. Investment banking, sales and trading, and research are the three key departments that create revenue for the bank. Investment banking is the practise of assisting clients in raising funds through capital markets and advising businesses on mergers and acquisitions. Sales and trade refers to the buying and selling of products by the bank (on behalf of the bank and its clients). Commodities and specialised derivatives are examples of traded products. Banks conduct research on firms and create reports about them. hopes for future earnings These reports are purchased by other financial professionals who use them for their own investing analyses. Commercial banking, merchant banking, investment management, and global transaction banking are all possible front office divisions for an investment bank.
Middle Management
Risk management, financial control, corporate treasury, corporate strategy, and compliance are common examples. The middle office’s ultimate purpose is to ensure that the investment bank does not engage in activities that are potentially harmful to the firm’s overall health. There is a lot of interaction between the front office and the middle office in capital raising to make sure the corporation isn’t taking on too much risk by underwriting particular securities.