What is Investment Banking?
Investment banking is often referred to as one of the two pillars of the global banking industry, along with retail (also known as commercial) banking. Investment bankers command high fees because they willfully engage in financially risky behaviors that other actors will not or cannot. There has been considerable attention paid to the industry since 2008, but many people have little to no idea of what investment bankers actually do. Here is a brief synopsis of activities undertaken by a typical global investment bank.
Also known as "prop" trading, proprietary trading is the closest thing to gambling that exists in the investment banking industry. Specific investors and traders within the organization are allowed to take funds from the bank itself and spend that money buying stocks, shares and derivatives in world stock markets. Their aim is to make the bank money without actually having to perform a service to clients or customers. This practice is very high risk, but often carries a high reward due to potentially massive margins.
In any stock market, just as in any market in general, there must be buyers and sellers. Markets cannot operate effectively, or correctly price goods, if these two groups do not exist. Investment banks have agreements with stock exchanges that they will trade regularly in the market, so that other buyers and sellers can join the market as well. Although this activity is not tremendously profitable, it is a mark of prestige for an investment bank to be known as a "market setter".
Mergers and Acquisitions
Investment banks often act as advisers to companies who are aiming to merge with each other, or as agents for a business that wants to complete a hostile takeover of a competitor. Bankers can help companies determine when to make their move and which sectors of a business to target. They can also provide assistance doing due diligence on another firm, or acquiring the necessary paperwork and regulatory body approval. Investment banks take a cut, or a percentage, of the total amount of the deal. This practice can be extremely lucrative if the merger is very large-scale, or the acquisition costs a great sum of money.
New Corporate Events
Corporate actors and firms often must raise new capital, for many different reasons. They typically do this by issuing new shares or bonds of the company. Investment bankers play a huge role in these new issuance scenarios. Banks advise clients on when to issue new shares, who to approach to buy the shares, how to price the new shares, and dozens of other smaller decisions. They may even underwrite the shares (for a hefty fee!), meaning that the bank agrees to buy excess shares that the company cannot sell. This practice makes banks gobs of money and opens up new investment opportunities for other divisions simultaneously.
There are many other activities that investment banks participate in across the financial spectrum. Many of them design financial products, assess financial risk in particular sectors and businesses, and advise clients on other corporate activities. Investment banks have an important role to play in the financial ecosystem, but that system is changing every day. Investment banking will have to reinvent itself in the post-financial crisis world in order to stay globally relevant.
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