| We hear the term "investment bank" on a daily basis. | | | | managing the amount of risk on its balance sheet, an |
| These banks are vilified for their role in the financial | | | | investment bank can maximize its profitability. |
| crisis and criticized for the profits they reap and the | | | | The sales and trading department also interacts with |
| large compensation packages for their employees. | | | | the corporate finance department on the issuance of |
| But many people have no idea what they are or | | | | IPOs and follow-on offerings. It is the sales and |
| what they do. Let's take a look at the role i-banks | | | | trading department that builds a book for a particular |
| play in the financial services industry and the | | | | stock by calling up institutional and retail investors to |
| economy at large. | | | | judge the interest for the offering. They then price |
| So what is an investment bank? First of all, they are | | | | the initial sales value on the day of the offering and |
| very different than the commercial banks we are all | | | | begin selling the new shares to their clients. |
| familiar with. They do not take deposits like the retail | | | | Depending on the size of an offering or the desired |
| bank on the corner. Instead, they primarily assist in | | | | mix of investors for the offering, several investment |
| the buying, selling and issuing of securities - that is | | | | banks may be involved in issuing shares to the public. |
| stocks, bonds and similar financial instruments. | | | | This group of banks constitute the syndicate and are |
| They assist companies and institutions on "buy side" | | | | responsible for selling the shares involved in the |
| and "sell side" activities. The buy side refers to the | | | | offering. |
| advising of institutions concerned with buying assets | | | | Research |
| and securities. Entities that engage in buy side | | | | The research department is staffed by research |
| activities include private equity funds, mutual funds, | | | | analysts. These are the people who often appear on |
| hedge funds, pension funds and proprietary trading | | | | business news programs and talk about the |
| desks. The sell side refers to a broad range of | | | | performance of a particular company or stock. The |
| activities, including broking and dealing securities, | | | | role of the research department is to analyze |
| investment banking, advisory functions and | | | | companies and writes research reports that discuss |
| investment research. | | | | their performance potential. These reports often |
| The core functions of an i-bank include investment | | | | include a "buy" or "sell" recommendation. |
| banking - otherwise known as corporate finance - | | | | The research department on its own does not |
| sales and trading and research. Some larger | | | | generate a lot of income. What it does do is influence |
| investment banks also perform other services like | | | | trading volume, which results in more fees for sales |
| investment management or merchant banking, but | | | | and trading. When a research analyst changes his or |
| let's take a closer look at the core three. | | | | her recommendation on a stock, many investors will |
| Investment Banking (Corporate Finance) | | | | then act on that recommendation and the sales and |
| Investment banking can be a confusing term because | | | | trading team earns more in trading fees. |
| many people use it to refer to any activities | | | | There exists, however, a conflict of interest |
| performed by an i-bank. More specifically, though, | | | | between research and other parts on the investment |
| investment banking refers to assisting companies | | | | bank. If an investment bank were about to issue |
| with raising capital and giving advice on mergers and | | | | new shares of stock for a company, for example, |
| acquisitions. | | | | the research analyst could put out a strong |
| The corporate finance department of a bank is the | | | | recommendation for the stock just prior to the |
| group that works with a company to put together | | | | offering, and the bank could get a better price and |
| an initial public offering (IPO). Or, if a company | | | | potential earn more fees. |
| already has public stock outstanding, they might put | | | | Likewise, if the proprietary trading division wanted to |
| together a follow-on offering, which is simply an | | | | boost the return on their holdings, they could have |
| additional issuance of stock shares. The corporate | | | | research analysts recommend some of the stock |
| finance department can also help companies raise | | | | they held as a buy. There are a number of areas |
| capital through private placements, which often | | | | where the research department could be used to |
| involve securing capital from private equity groups. | | | | mislead investors and earn more profit for the |
| Should the ownership of a company seek to sell the | | | | investment bank. |
| entire enterprise, the corporate finance department | | | | To circumvent these conflicts of interests, regulators |
| can also advise on M&A transactions. They can help | | | | have insisted that investment banks implement a |
| identify potential buyers and negotiate a sale of the | | | | "Chinese wall" in their firms. The Chinese wall keeps |
| entire company. Likewise, if a company is in the | | | | information about the investment bank's corporate |
| market for acquiring other enterprises, this group can | | | | finance and sales and trading activities from passing |
| advise on acquisitions. | | | | through to the research department. |
| Another service that the corporate finance | | | | A Chinese wall also exists between the corporate |
| department might offer is the delivery of fairness | | | | finance and sales and trading divisions because many |
| opinions. In a fairness opinion, an investment bank will | | | | corporate finance activities involve non-public |
| perform an analysis of a potential acquisition and | | | | information that could be used to profitably execute |
| render an opinion as to whether a reasonable price is | | | | trading strategies. |
| being offered for the target company. | | | | A World without I-Banks |
| Sales and Trading | | | | Without investment banks, companies would have a |
| Sales and trading is perhaps the primary service that | | | | much more difficult time with raising capital. Likewise, |
| an i-bank can offer. There are often two major | | | | the general public would have a hard time investing |
| divisions within sales and trading - institutional and | | | | their money in anything other than a savings deposit. |
| retail. The institutional division buys and sells financial | | | | Without i-banks, only very large institutions or very |
| products for institutional clients such as mutual funds, | | | | wealthy individuals would be able to structure the |
| pension funds, etc. The retail division buys and sells | | | | same financial transactions that occur every day with |
| financial products for retail investors. Stock brokers | | | | an i-bank. |
| fall into this area. | | | | In short, these banks drastically speed up the flow of |
| The sales and trading department engages in market | | | | capital throughout the economy and allow businesses |
| making. Market making involves buying and selling | | | | - and our savings - to grow more quickly. As |
| financial instruments in order to make an incremental | | | | complicated as all these activities may seem, they |
| profit on each trade. | | | | only scratch the surface of all the intricacies of these |
| Sales and trading can also engage in proprietary | | | | banks. |
| trading. Proprietary trading involves a special group of | | | | But the next time you hear that some investment |
| traders who do not work with clients. These traders | | | | bank advised on the sale of a company or generated |
| take on "principal risk", which involves buying or selling | | | | several billing dollars in trading fees, at least you'll |
| a product and does not hedge his total exposure. By | | | | have an idea of what they're talking about. |