You may have heard the term investment banking, but what exactly is it? Investment banking actually refers to a division of the bank or a financial institution that serves governments, corporations and institutions by providing underwriting services, as well as mergers and acquisitions advisory services. Investment banks/bankers act as an intermediary between the client or investor and the corporation which requires capital in order to grow and run their entity.
So, what exactly does investment banks or bankers do? Generally speaking, full-service investment banks will offer the following services: underwriting, mergers and acquisitions, sales and trading, equity research and asset management. Essentially, investment bankers are sort of like corporate financial advisers as they tend to deal with corporations and governments rather than individuals.
Investment bankers in short, advise and help their clients (corporations and governments) raise capital through the above-mentioned services. This will generally mean that if the capital markets are booming, then investment bankers will tend to do well too since they can generate more revenue from their activities.
Underwriting Services in Investment Banking
Underwriting is the process of raising revenue through selling stocks or bonds to investors on behalf of corporations. As businesses require money in order to operate and grow, investment bankers help them generate that revenue through marketing the company to investors. This means that they manage the risk inherent to the process by purchasing the securities from issuers and selling them to investors. Investment bankers tend to buy the securities at one price and then mark up the sale price, which will in return generate revenue.
There generally are three types of underwriting that investment bankers do:
- Firm Commitment – the investment banker purchases the entire issue and assume full financial responsibility for any unsold shares
- Best Efforts – the investment banker commits to selling as much of the securities as possible at an agreed price, but they can return any unsold shares to the issuer without taking on any financial responsibility for any unsold shares.
- All-or-None – the investment banker will sell the entire issue at a price, and if it cannot be sold, the deal will be called off and the issuer will receive nothing.
Arranging Finance as an Investment Banker
Sometimes when a large corporation is looking to build a factory and are looking to issue bond financing to finance its expansion, they may seek an investment banker for help. This routine is similar to if the government wants to finance the building of an airport, highway or other large projects, they may want to work with an investment banker in order to generate revenue.
Generally, in the case of arranging finances, the investment banker would be the one to plan the bond issuance, the price of the bonds as well as work with the issuer to provide required documentation to issue and sell these bonds.
Mergers and Acquisitions
While the phrase “Mergers and Acquisitions” may have been made popular through the film – American Psycho, unlike the movie, it’s a bit more than just handing out embossed business cards.
Mergers and Acquisitions generally refers to the investment banker offering advice about the acquisition when a corporation is looking to purchase another. Sometimes, investment bankers need assist these corporations into finding, evaluating and completing the acquisition offer, including pricing the offer.
Mergers and Acquisitions can work both ways, as companies who are looking to sell can also contact an investment banker to do the above.
While investment banking seems like a great industry to get into, they have not gone by without criticism. As investment bankers can work with large corporations, institutions and even the government, there is a possibility for conflict of interest for those who have access to confidential information which can be sold to certain investors. This can potentially become an unfair advantage for investors who do not have the same information.