If you're new to the world of investment banking, you're probably lost in the complexity of the finance industry. The following primer explains the nuts and bolts of investment banks and what they're all about.
In basic terms, investment banks transfer money and risk. They move money from the people who have it to those who need it. They move risk from people who do not want to deal with it to those who are comfortable taking it on. The ways in which this is done depends on the banking division you're working with.
The majority of investment banks have four main divisions: Sales and Trading, Research, Asset Management, and Investment Banking. Below is a summary of the main tasks each division performs.
The sales and trading division is the one that most likely comes to mind when you think of investment banking. This division buys and sells securities for clients, including equity (stocks), fixed income (bonds), and commodities and currencies (oil, ore, electricity, gold). Most of the transactions involve deals concerning thousands of shares and millions of dollars. Clients are generally major financial entities, such as money and pension fund managers, foreign government bodies, insurance companies, and commercial banks. Those who work in this division either focus on sales, taking client orders for securities, or trading, in which they link up buyers and sellers by finding mutually agreeable prices. Traders also ensure their positions are hedged by making sure they do not lose money regardless of market conditions. To take a simple example, traders might buy shares of electric generators to counteract shares they hold in electricity. If the price of electricity drops, the trader does not lose money because lower electricity prices make generators more profitable, and therefore their price rises in reaction.
Professionals in the research division do the work of the analysts you see talking about their expectations for particular companies when you watch the news. Their role is to advise the banks' clients, as well as the traders, on these matters. They gather information by looking at the working of the companies they cover in depth, including reading earnings reports, visiting factories, and reading foreign newspapers. They are accessible to their clients or other company employees around the clock to answer questions about investment strategies, and they often write many research reports detailing their findings.
The asset management team manages money. Asset managers generally manage portfolios for wealthy clients, pension and mutual funds, and insurance companies. They may invest in stocks, bonds, or any other form of asset. Often, special groups of asset managers concentrate on private equity or venture capital, where they invest in high risk startups that carry potentially high returns. Asset managers purchase the services of the sales and trading group in order to buy and sell securities for their portfolios. They likewise pay the researchers to learn about which securities they should include.
Practically every other function falls within the investment banking category. One major role of this group is to underwrite securities such as stocks or bonds. Companies seeking money to invest in capital either borrow it from the public (issue bonds) or sell portions of the company (issue stocks, known as IPO). Whichever method they choose, they are assisted by investment banks, which take them through the process, from the initial government filings to the marketing materials and selling the stocks and bonds to the public. Banks provide local governments such assistance by issuing municipal bonds. An increasingly common asset is the securitized bond, particularly because it offers reduced risk. Securitized bonds are unique in that instead of representing ownership of a loan to a company, they may instead represent rights to the proceeds from a company's income.
The investment banking division is also heavily involved in providing advisory services, i.e., helping companies with their finances. These services are typically required in mergers and acquisitions (M&A), when companies are seeking to buy others. In such situations, an investment bank assists in arranging the financing for the transaction and directing the unification.
To summarize, investment banks shift funds. They likewise move risk from those who have money to take chances with to those who need it. The banks handle everything from the company trying to build a factory, paying extra for risk coverage, to the mutual fund manager investing money in a startup venture. Investment banks are one stop shops for those seeking capital for projects and those looking to loan their money out.
Robin Trehan is a financial expert.
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