Investment Banking - Explained
What is Investment Banking?
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Table of ContentsWhat is Investing Banking?How Does Investment Banking Work?Investment Bankers: Their Company Roles and DutiesExample of Investment Banking
What is Investing Banking?
Investment Banking refers to a special division in banking that is dedicated to the generation of income or principal for other firms, government bodies, and related entities. Investment banks issue new debt instruments, offer equity deals to corporations of any kind, assists firms in the sales of securities, and aid in company acquisition or merger processes. They also act as brokers in trades, conduct and facilitate international exchanges, and deal on behalf of big and small business entities, as well as other bodies or individuals. It is not unusual to see investment banks providing guidance and assistance to stock and securities issuers in Initial Public Offerings (IPOs) as regards how much a stock should cost, how it should run, and what units to release to the market.
How Does Investment Banking Work?
A number of the most famous investment banks across the country are associated with larger banks which serves commercial or other purposes. Most of them however, are more like subsidiaries of bigger banks, and they have grown to become trusted names in the financial sector. Top examples of investment banks in the United States includes; Goldman Sachs, Morgan Stanley, JP Morgan Chase, Bank of America Merrill Lynch (associated with Bank of America), and the famous Deutsche Bank which has helped launched and sustained several firms in the nation. These investment banks as well as many others help mostly in deals with large transactional values and high risks. These banks mostly assist firms in making decisions on the value of a company, and how well to lead or structure a deal in cases related to mergers, acquisitions, or sales. They also assist in issuing securities and fixing stock prices for companies that are in the process of going public, as well as help in creating and submitting documents required by the Securities and Exchange Commission for newly created companies.
Investment Bankers: Their Company Roles and Duties
Investment bankers are individuals who take on the task of identifying and preventing issues related with the launching and operations of large projects. Investment banks primarily employs these individuals and they are mostly concerned with assisting big corporations, government bodies, and wealthy entities organize and strategize enormous projects, thus resulting in more time for the clients, and they also take on the task of identifying certain risks both future and present related to a project, to prevent or mitigate the possibility of lost investments. Big and small businesses find it easier to get help from investment bankers, and this results to a great and growing number of clients for investment banks. These individuals are highly trained to spot trends and discern economic matters, and for this reason, they can give well tailored and expert advice to growing or new corporations on how best to launch, what practices to follow, what operations to carry out, and how to get financing, depending on the economic status of the nation at that time. Since investment bankers are highly trained in the act of investing, it is very possible to see even standard corporations and household names rush to them for help or recommendations on how they should carry out a project, or what they should invest in, and how they should invest in it. Investment banks can be said to serve as middlemen between companies and investors, in a situation where a said firm wishes to launch an IPO, or issue more portions of their stocks, as well as debt instruments like bond. These banks are contracted for the purpose of identifying and controlling regulatory requirements, as well as placing prices on shares or bonds to maximize the company revenue. In some Initial Public Offerings, an investment bank might choose to buy all of a company's shares, or some part of it, and later resell it to investors on the market. This way, the firm that owns the shares will be safe from market risk as the investment bank has bought all available units. This then gives the investment bank the full right to transfer units of these shares to investors on demand. In some cases, the investment bank will turn in a large profit, but more often than not, there is a possibility of a loss, as they might have overvalued the stock during appreciation (a process where a monetary value is placed on a security, asset, or debt instrument). To mitigate the risk of losing in the market, investment banks usually hire securities analysts to place value on a unit of share in a company. The risk of hoarding and holding the shares is transferred to the investment bank from the company, as well as any possibility of making a profit.
Example of Investment Banking
Let us assume that a company CSX Corporations which produces fashion wears wishes to become publicly-traded. By publicly-traded, we mean that the firm wishes to receive investment from the general public, and in exchange, it will issue shares to those who invest. Now, assume that the owner of CSX corporations is Collins. Collins decides to discuss matters with an investment banker John who is currently working at one of the best investment banks in the nation. After a series of discussions, John agrees to buy up to 200,000 units of Collinss company shares at a price of $10 per unit. This monetary amount was carefully decided by the banks stock analyst so as to reduce loss and maximize profit. Later on, Collins decides to go with Johns offer, and the investment bank purchases 200,000 units of these shares using $2 million. They later go on to sign the appropriate paperwork and begin issuing out these shares to investors at $15 per unit. The investment bank however finds it hard to sell more than 10% of the company's shares at this price, and this makes then reduce it down to $12 per unit. Even at the new price, they still had 70% of unsold units, so they decided to go less than the cost price to $8 per unit of share. Using these details, we can see that Johns investment bank made $1.9 million from the IPO deal. From here, it is accurate to say that Johns firm lost $100,000 because they overvalued Collins's shares. Most investment banks realize losses in IPO deals because they are constantly trying to beat their competitors. Since there is a possibility of a gain when a company decides to go public, investment banks will compete against each other in securing an IPO deal, and this can make them raise their offers even more than what their securities analysts recommend. In some cases, more than one investment bank can take on the process of issuing stocks on behalf of a company. This process is known as underwriting. Here. Two investment banks can decide to valuate stocks, launch the IPO on behalf of the firm, and sell out the units to investors on demand. While this might lead to lower risks, it is important to note that it reduces the chances of substantial profits which is the main reason why investment banks look for IPOs. Also, if the competition for a company's shares is extremely high, the winning investment bank might suffer a large loss, as it might have offered a highly underserved amount for the company shares in order to win the deal.