Investment Banking


DEFINITION of 'Investment Banking '

Investment banking is a specific division of banking related to the creation of capital for other companies, governments and other entities. Investment banks underwrite new debt and equity securities for all types of corporations, aid in the sale of securities, and help to facilitate mergers and acquisitionsreorganizations and broker trades for both institutions and private investors. Investment banks also provide guidance to issuers regarding the issue and placement of stock.

BREAKING DOWN 'Investment Banking '

Many large investment banks are affiliated with or subsidiaries of larger banking institutions, and many have become household names, the largest being Goldman Sachs, Morgan Stanley, JPMorgan Chase, Bank of America Merrill Lynch and Deutsche Bank. Broadly speaking, investment banks assist in large, complicated financial transactions. This may include advice as to how much a company is worth and how best to structure a deal if the investment banker’s client is considering an acquisition, merger or sale. It may also include the issuing of securities as a means of raising money for the client groups, and creating the documentation for the Securities and Exchange Commission necessary for a company to go public.

Investment banks employ investment bankers who help corporations, governments and other groups plan and manage large projects, saving their client time and money by identifying risks associated with the project before the client moves forward. In theory, investment bankers are experts in their field who have their finger on the pulse of the current investing climate, so businesses and institutions turn to investment banks for advice on how best to plan their development, as investment bankers can tailor their recommendations to the present state of economic affairs.

Essentially, investment banks serve as middlemen between a company and investors when the company wants to issue stock or bonds. The investment bank assists with pricing financial instruments so as to maximize revenue and with navigating regulatory requirements. Often, when a company holds its initial public offering (IPO), an investment bank will buy all or much of that company’s shares directly from the company. Subsequently, as a proxy for the company holding the IPO, the investment bank will sell the shares on the market. This makes things much easier for the company itself, as they effectively contract out the IPO to the investment bank. Moreover, the investment bank stands to make a profit, as it will generally price its shares at a markup from the price it initially paid. Yet, in doing so the investment bank also takes on a substantial amount of risk. Though experienced analysts at the investment bank use their expertise to accurately price the stock as best they can, the investment bank can lose money on the deal if it turns out they have overvalued the stock, as in this case they will often have to sell the stock for less than they initially paid for it.

For example, suppose that Pete’s Paints Co., a chain supplying paints and other hardware, wants to go public. Pete, the owner, gets in touch with Jose, an investment banker working for a larger investment banking firm. Pete and Jose strike a deal wherein Jose (on behalf of his firm) agrees to buy 100,000 shares of Pete’s Paints for the company’s IPO at the price of $24 per share, a price at which the investment bank’s analysts arrived after careful consideration. The investment bank pays $2.4 million for the 100,000 shares and, after filing the appropriate paperwork, begins selling the stock for $26 per share. Yet, the investment bank is unable to sell more than 20% of the shares at this price and is forced to reduce the price to $23 per share in order to sell the remaining shares. For the IPO deal with Pete’s Paints, then, the investment bank has made $2.36 million [(20,000 x $26) + (80,000 x $23) = $520,000 + $1,840,000 = $2,360,000]. In other words, Jose’s firm has lost $40,000 on the deal because it overvalued Pete’s Paints.

Investment banks will often compete with one another for securing IPO projects, which can force them to increase the price they are willing to pay to secure the deal with the company that is going public. If competition is particularly fierce, this lead to a substantial blow to the investment bank’s bottom line. Most often, however, there will be more than one investment bank underwriting securities in this way, rather than just one. While this means that each investment bank has less to gain, it also means that each one will have reduced risk.

Want to learn more about Investment Banking? Check out What's the Role of an Investment Bank?, The Rise of the Modern Investment Bank, The World's Top 10 Investment Banks and Financial Careers: Investment Banking Jobs.

  1. Investment Banker

    Someone working at an institution raising capital for companies, ...
  2. Reorganization

    A process designed to revive a financially troubled or bankrupt ...
  3. Investment Bank - IB

    A financial intermediary that performs a variety of services. ...
  4. Tax Accounting

    Accounting methods that focus on taxes rather than the appearance ...
  5. Bank Reserve

    Bank reserves are the currency deposits which are not lent out ...
  6. Bank

    A financial institution licensed as a receiver of deposits. There ...
Related Articles
  1. Professionals

    The Best Financial Modeling Courses for Investment Bankers

    Obtain information, both general and comparative, about the best available financial modeling courses for individuals pursuing a career in investment banking.
  2. Retirement

    What Was The Glass-Steagall Act?

    Established in 1933 and repealed in 1999, the Glass-Steagall Act had good intentions but mixed results.
  3. Professionals

    Common Interview Questions for Investment Bankers

    Explore some of the most commonly asked questions in an interview for an investment banking position, along with suggestions for winning answers.
  4. Professionals

    4 Reasons Private Banking Is the Right Career For You

    Learn how a strong income potential, good hours, strong client relationships and low stress might make private banking the ideal career for you.
  5. Professionals

    Career Advice: Investment Banking Vs. Law

    Learn some of the most important differences between a career in investment banking and law, and figure out which career suits you better.
  6. Professionals

    Career Advice: Management Consulting Vs. Investment Banking

    Compare the career opportunities available in management consulting and investment banking. Learn about salaries, skills needed and work-life balance.
  7. Investing

    What's Investment Banking?

    An investment bank is a special type of bank involved in a variety of large and complex financial services for major institutions.
  8. Insurance

    The Rise Of The Modern Investment Bank

    Get to know a little bit about the institutions whose actions help to guide free markets.
  9. Professionals

    Top Things To Know For An Investment Banking Interview

    Without some basic knowledge, you won't get the job. Find out what you need to know and how to prepare.
  10. Professionals

    How To Write An Effective Investment Banking Resume

    A persuasive resume can give you the edge you need in a competitive market.
  1. What does the 'FIG' at an investment bank refer to?

    The 'FIG' at an investment bank usually refers to the financial institutions group - a group of professionals that provides ... Read Full Answer >>
  2. Do financial advisors have to find their own clients?

    Nearly all financial advisors, particularly when new to the field, have to find their own clients. An employer may provide ... Read Full Answer >>
  3. Do financial advisors get drug tested?

    Financial advisors are not drug tested by any federal or state regulatory body. This means you may receive your Series 6, ... Read Full Answer >>
  4. Is a financial advisor required to have a degree?

    Financial advisors are not required to have university degrees. However, they are required to pass certain exams administered ... Read Full Answer >>
  5. Do financial advisors have to be licensed?

    Financial advisors must possess various securities licenses in order to sell investment products. The specific products an ... Read Full Answer >>
  6. Do financial advisors need to meet quotas?

    Most financial advisors are required to meet quotas, particularly if they work for firms that pay base salaries or draws ... Read Full Answer >>

You May Also Like

Trading Center