An investment bank is a financial institution that raises capital, trades securities and manages corporate mergers and acquisitions. Another term for investment banking is corporate finance.
Investment banks work for, and profit from, companies and governments, by raising money through issuing and selling securities in capital markets (both equity and debt) and insuring bonds (e.g. selling credit default swaps), and providing advice on transactions such as mergers and acquisitions. A majority of investment banks offer strategic advisory services for mergers, acquisitions, divestiture or other financial services for clients, such as the trading of derivatives, fixed income, foreign exchange, commodity, and equity securities.
In terms of regulatory qualification, to perform these services in the United States, an adviser must be a licensed broker-dealer, and is subject to Securities & Exchange Commission (SEC) (FINRA) regulation. Until 1999, the United States maintained a separation between investment banking and commercial banks. Other industrialized countries, including G7 countries, have not maintained this separation historically. Trading securities for cash or securities (i.e., facilitating transactions, market-making), or the promotion of securities (i.e., underwriting, research, etc.) was referred to as the "sell side".
Dealing with the pension funds, mutual funds, hedge funds, and the investing public who consumed the products and services of the sell-side in order to maximize their return on investment constitutes the "buy side". Many firms have buy and sell side components.
Organizational structure of an investment bank
Main activities and units
An investment bank is split into the so-called front office, middle office, and back office. While large full-service investment banks offer all of the lines of businesses, both sell side and buy side, smaller sell side investment firms such as boutique investment banks and small broker-dealers will focus on investment banking and sales/trading/research, respectively.
Investment banks offer security to both corporations issuing securities and investors buying securities. For corporations investment bankers offer information on when and how to place their securities in the market. The corporations do not have to spend on resources with which it is not equipped. To the investor, the responsible investment banker offers protection against unsafe securities. The offering of a few bad issues can cause serious loss to its reputation, and hence loss of business. Therefore, investment bankers play a very important role in issuing new security offerings.
Core investment banking activities
- Investment banking is the traditional aspect of the investment banks which also involves helping customers raise funds in the capital markets and advise on mergers and acquisitions. Investment banking may involve subscribing investors to a security issuance, coordinating with bidders, or negotiating with a merger target. Another term for the investment banking division is corporate finance, and its advisory group is often termed mergers and acquisitions (M&A). The investment banking division (IBD) is generally divided into industry coverage and product coverage groups. Industry coverage groups focus on a specific industry such as healthcare, industrials, or technology, and maintain relationships with corporations within the industry to bring in business for a bank. Product coverage groups focus on financial products, such as mergers and acquisitions, leveraged finance, equity, and high-grade debt and generally work and collaborate with industry groups in the more intricate and specialized needs of a client.
- Sales and trading : On behalf of the bank and its clients, the primary function of a large investment bank is buying and selling products. In market making, traders will buy and sell financial products with the goal of making an incremental amount of money on each trade. Sales is the term for the investment banks sales force, whose primary job is to call on institutional and high-net-worth investors to suggest trading ideas (on caveat emptor basis) and take orders. Sales desks then communicate their clients' orders to the appropriate trading desks, who can price and execute trades, or structure new products that fit a specific need. Structuring has been a relatively recent activity as derivatives have come into play, with highly technical and numerate employees working on creating complex structured products which typically offer much greater margins and returns than underlying cash securities. Strategists advise external as well as internal clients on the strategies that can be adopted in various markets. Ranging from derivatives to specific industries, strategists place companies and industries in a quantitative framework with full consideration of the macroeconomic scene. This strategy often affects the way the firm will operate in the market, the direction it would like to take in terms of its proprietary and flow positions, the suggestions salespersons give to clients, as well as the way structurers create new products. Banks also undertake risk through proprietary trading, done by a special set of traders who do not interface with clients and through "principal risk", risk undertaken by a trader after he buys or sells a product to a client and does not hedge his total exposure. Banks seek to maximize profitability for a given amount of risk on their balance sheet. The necessity for numerical ability in sales and trading has created jobs for physics and math Ph.D.s who act as quantitative analysts.
- 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 by 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.
Other businesses that an investment bank may be involved in
- Global transaction banking is the division which provide cash management, custody services, lending, and securities brokerage services to institutions. Prime brokerage with hedge funds has been an especially profitable business, as well as risky, as seen in the "run on the bank" with Bear Stearns in 2008.
- Investment management is the professional management of various securities (shares, bonds, etc.) and other assets (e.g. real estate), to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or private investors (both directly via investment contracts and more commonly via collective investment schemes e.g. mutual funds). The investment management division of an investment bank is generally divided into separate groups, often known as Private Wealth Management and Private Client Services.
- Merchant banking is a private equity activity of investment banks. Current examples include Goldman Sachs Capital Partners and JPMorgan's One Equity Partners. (Originally, "merchant bank" was the British English term for an investment bank.)
- Commercial banking see article commercial bank. Examples being Goldman Sachs and Morgan Stanley growing into the commercial banking businesses even before the financial crises of 2008.
Middle office
- Risk management involves analyzing the market and credit risk that traders are taking onto the balance sheet in conducting their daily trades, and setting limits on the amount of capital that they are able to trade in order to prevent 'bad' trades having a detrimental effect to a desk overall. Another key Middle Office role is to ensure that the above mentioned economic risks are captured accurately (as per agreement of commercial terms with the counterparty), correctly (as per standardized booking models in the most appropriate systems) and on time (typically within 30 minutes of trade execution). In recent years the risk of errors has become known as "operational risk" and the assurance Middle Offices provide now includes measures to address this risk. When this assurance is not in place, market and credit risk analysis can be unreliable and open to deliberate manipulation.
- Corporate treasury is responsible for an investment bank's funding, capital structure management, and liquidity risk monitoring.
- Financial control tracks and analyzes the capital flows of the firm, the Finance division is the principal adviser to senior management on essential areas such as controlling the firm's global risk exposure and the profitability and structure of the firm's various businesses. In the United States and United Kingdom, a Financial Controller is a senior position, often reporting to the Chief Financial Officer.
- Corporate strategy , along with risk, treasury, and controllers, often falls under the finance division as well.
- Compliance areas are responsible for an inves
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