Learn the definition of investment banking covering the role and activities of these banks serving customers the world over.
The Meaning of Investment Banking
In simple terms, investment banking refers to a field that deals with the underwriting of securities issued by clients of the bank, which is known as an investment bank. The bank can also act as an agent in the issuance of securities as well as offer a range of other services such as trading of equity securities and making among others. Read about the role the various activities, as follows:
Role of the Investment Banker
Investment bankers play an important role in the securities market. Most public security offerings are made with the assistance of the investment bank. This is a financial intermediary that specializes in selling new securities. Underwriting is the main activity of this banker. This process involves purchasing the security issue from the issuing firm at an agree price and then bearing the risk or selling it to other investors at a profit. This banker also provides the issuer with advice about pricing and other important aspects of the security issue.
In the case of very large security issues, the investment banker will bring in other bankers or partners to form an underwriting syndicate. They do this in order to spread the financial risk when buying the entire issue from the issuer and reselling the new securities at a profit to other investors. The originating banker and the syndicate members put together a selling group, normally made up of themselves and a number of brokerage firms. All members of the selling group accept the responsibility for selling portions of the issue and receive commissions for the securities they sell.
Investment Banking Activities
There exists two main lines in investment banks; sell side and buy side. Sell side generally involves trading of securities either for cash or other securities, or promotion of securities. It also involves raising capital for businesses such as initial public offering ipo. The buy side, on the other hand, entails providing advice to institutions that want to purchase investment services. Entities may include mutual funds, hedge funds, life insurance companies, private equity funds, initial public offerings and unit trusts. In general, roles of investment banks are grouped into three categories. These include:
1. Front Office of the Investment Bank
This typically involves revenue generation and is further divided into investment banking and markets. Investment banking entails advising organizations on a range of issues such as mergers, acquisitions and fund raising strategies. Bankers regard this as not just the most prestigious, but also the highest paying, bank department. Markets, on the other hand involves sales, trading, research, structuring and other activities. It’s important to note that while an investment banker is likely to make more than a trader, the best trader has a considerably higher chance of making more than the best investment bankers.
2. Middle Office of the Investment Bank
Middle office roles in in this type of financial institution take a more risk management/cost cutting approach because they involve analyzing and evaluating risks that those in the front office take. Measures can include setting limits to amounts of funds available to trade among others. Here they may have to make decisions on financial services, capital markets, mergers and acquisitions and corporate finance. Additionally, investment bankers can deal with capital market and fixed income instruments.
3. Back Office of the Investment Bank
This mainly involves operations and asset management. The employees have to make transfers, ensuring that they do not make errors or mistakes while handling the customers’ transactions. Back office can also include the technology division, as with commercial banking.