The purpose of Investment Banking is to put in touch, through the financial markets, buyers (both private and institutional) who have savings and businesses in need of resources to finance their investments.
This brief definition, which sees investment banks acting as financial intermediaries, no longer seems able to include all of the activities that have been developed over time by these operators.
From their traditional activity of underwriting (assistance in the issuing of stocks and in finding buyers, which will be explained further on), investment banks have through time developed and diversified their business and they now also offer a vast range of other services. These include finding funds within the capital markets, financial advice regarding mergers and acquisitions, assistance in refinancing for businesses and in dealing with rights issues, and even financial services such as project financing, administrating funds, stock market trading, wealth management, brokerage etc.
From this picture, it is clear that it is difficult to define a clear limit to the activities carried out by investment banks. They can even choose to offer only a few of these services and in different ways.
We can try to resolve these difficulties by classifying the activities of investment banks according to the entities to which they are offered; namely businesses and private investors.
Therefore, we can distinguish between:
- services offered to public and private sectors (underwriting, corporate finance and merchant banking);
- trading in stocks for themselves or on behalf of others.
This is the traditional business of investment banks and is part of their core-business. It consists mainly of giving advice to companies that want to offer shares and bonds to the public.
The advice can regard the entire offering process, by setting out the terms and conditions of a future emission and even the public placing. An investment bank offers its experience in determining the technical characteristics and organisation of the public offering. The placing of stocks on a market, however, is far more difficult. A primary consideration is the prestige of the bank that is dealing with the public offering: the less well-known a bank is in the market in which it wants to issue stocks, the greater the notoriety effect of the bank dealing with the floatage. Often the big names of the financial world give the best guarantee, or at least this is how it is perceived by investors. Another important consideration is the strength of the relationship the bank already has with the market. Choosing a bank with a low level of visibility and experience instead of another one with a shady reputation can undermine the public floatation. The big players in investment banking often have a strong and consolidated relationship with market investors (both private and institutional) and potential subscribers. The investment bank does not normally have any obligations towards the nominal amount that is offered and remains unrequested, except perhaps to agree to sell at the best possible price any unwanted stocks.
On other occasions, the investment bank agrees to buy unsold stocks at a pre-established price. In this case, the bank in question can decide to undertake the public offering together with other banks to reduce any price risk in the public offering. Alternatively, the issuer can resort to floatation through an auction system. Here, once the general conditions of the stocks are made known, the bank considers all the offers and accepts those with the best price/quantity combination.
2. Corporate Finance
With the general term "corporate finance", we refer to the counselling and assistance service that investment banks offer to businesses involved in mergers and acquisitions and in the restructuring of debt. Some of the emissions that investment banks deal with for companies are carried out simply to create financial resources in view of a future merger and acquisition with other companies. Here investment banks are not only responsible for finding capital but, more importantly, also for providing assistance to a company involved in a Merger & Acquisition deal by helping it to search for potential target companies by outlining the terms and conditions of the operation and by preventing possible future takeovers. As for debt refinancing, the aim of this activity is to re-stabilise the financial situation of the company. Investment banks assist businesses with operations that improve their financial position, with the goal of optimizing business or, in some cases, helping them to make a recovery. They can do this by issuing new shares, consolidating or increasing a company’s debt, or by converting its credit into other asset classes.
3. Negotiating stocks
Stock trading represents a major source of revenue for investment banks. As mentioned at the beginning, this service differs from others discussed up to now in that it is not entirely directed to private businesses, but to the market as a whole. The bank can either trade in stocks and shares for itself (dealing), and therefore for its own portfolio, or for third parties (brokerage). The profit from such transactions comes mainly from the difference between the bid/ask prices or from the increase in value of the stocks held in portfolio.
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