What is Investment Banking?

Published by Thomas Herold in Banking, Corporate Finance, Investments, Trading

'Investment Banking' is explained in detail and with examples in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Investment Banking refers to a particular subdivision of banking. This investment type of banking pertains to developing capital for governments, organizations, and corporations. Investment banks will come up with new equity and debt securities to float and sell them on behalf of any corporation. They also facilitate mergers and acquisitions and company reorganizations. They help to sell the securities and broker major trades for private investors and institutions. Besides this, they give guidance to those issuing stocks on the placement and floating of stock issues.

A great many of the bigger investment banks prove to be associated with (or wholly or partially owned by) bigger financial and banking institutions. A number of them have evolved into house hold known names. The biggest of these famous investment banks are Goldman Sachs, JPMorgan Chase, Morgan Stanley, Bank of America Merrill Lynch, HSBC, and Deutsche Bank.

In general, such investment banking fosters huge, complex, often international in nature financial transactions. This might come with advisory services on the best ways to structure deals when the customer is interested in engaging in a sale, merger, or acquisition. Other firms may want to know how much a certain company is worth. The investment banks may need to float and sell securities in order to raise money for the groups of clients. Someone will have to develop the documents which the SEC Securities and Exchange Commission requires in order for companies to be taken public.

The investment banking groups hire investment bankers who assist their clients (the governments, organizations, and corporations) in planning for, setting up, and managing enormous projects. This saves a great deal of money and time for the clients through identifying any risks common to the project before the project starts. The idea is that investment bankers are highly trained experts in the financial services fields. They are supposed to have a wealth of knowledge, background, and advice to offer their clients for the best way to plan developments so the company can pursue the best recommendations for the current state of economics pertaining to the company’s particular project.

One can also think of the investment banks as not only an advisor but a middle man. They offer the useful go-between for companies and the investing public who want to purchase such new bond and stock issues. Investment banks package together financial securities and instruments so that the companies can optimize their revenues and safely come through the often complex regulatory environments.

For example, in many cases where companies launch their first IPO initial public offering, the underwriting investment banks will purchase most or all of the new shares straight off of their client the company. They then re-sell these IPO shares on the stock markets. The company gets a big single payday upfront this way and the investment bank acts as a contractor for the actual IPO underwriting. The investment banks typically profit well, as they usually re-price the shares with a nice markup on their original purchase price. This also entails a serious amount of risk though. If they overprice the stock shares, then they may not be able to sell all the shares and instead could end up selling them at a loss to the price they initially paid for them in the first place.

It is not at all uncommon for various investment banks to compete with each other for the best new IPO underwriting opportunities, and sometimes they end up working together on enormous ones. It could lead to a higher per share price being realized for the company which is going public. When the competition for the project becomes particularly intense, it can hit the investment bank’s profit margins. In these cases what often happens is that several of the major investment banks will underwrite a portion of the securities, often in different jurisdictions such as EuroNext, NYSE, and London Stock Exchange. The advantages to the investment banks are that the risk becomes spread around and reduced this way.

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The term 'Investment Banking' is included in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.