An investment bank is a financial services company that brokers large and complex financial transactions and deals.
An investment bank typically becomes involved when a startup prepares to launch its initial public offering (IPO) and when a company merges with a competitor. An investment bank also plays a brokerage or financial advisor role for large institutional clients, such as pension funds.
Global investment banks include JPMorgan Chase, Goldman Sachs, Morgan Stanley, Citigroup, Bank of America, Credit Suisse and Deutsche Bank.
Many of these investment banks also offer open-end banking services and have divisions that serve the investment needs of the wealthy.
How an investment bank works
An investment bank’s advisory department is paid a fee for advisory services. The trading department receives commissions based on its performance in the market. As noted, many investment banks also have retail banking divisions that make money by lending money to consumers and companies.
Professionals who work at investment banks can pursue careers as financial advisors, traders or salespeople. Careers at an investment bank are lucrative, but usually require many hours of work time and considerable stress.
An investment bank is an intermediary
Investment banks are best known for their work as intermediaries between a company and the financial markets. That is, they help corporations issue stock in an IPO or additional public offering. They also arrange debt financing for corporations by finding large investors for corporate bonds.
The investment bank’s advisory role begins with advising before underwriting and continues after the securities are distributed.
The investment bank is responsible for reviewing a company’s financial statements for accuracy and publishing a company prospectus that details the offering to investors before the securities become available for purchase.
Investment bank clients include corporations, pension funds, other financial institutions, governments and hedge funds.
Size is an advantage for investment banks. The more connections a bank has with the global financial community, the more likely it is to profit by attracting buyers and sellers, especially for unique deals and offers.
The operations of an investment bank can be roughly divided into three main functions:
Financial Advisor.
As a financial advisor to large institutional investors, an investment bank can provide strategic advice on various financial matters.
Investment banks perform this role by combining a deep understanding of their clients’, industry and global markets’ objectives with the strategic vision necessary to identify and assess short- and long-term opportunities and challenges.
Involvement in mergers and acquisitions
Participating in mergers and acquisitions is a key element of an investment bank’s work.
The investment bank estimates the value of a potential takeover and helps negotiate a fair price for it. The investment bank also helps in structuring and simplifying the takeover process so that the deal goes as smoothly as possible.
Conducting research and analysis on companies
Investment banks have research departments that review companies and write reports on their prospects, often with buy, hold or sell ratings. This research may not generate revenue directly, but it helps traders and the sales department.
The research department also provides investment advice to outside clients who can make a trade through the bank’s trading department, which will generate income for the bank.
Research supports the investment bank’s institutional knowledge of credit research, fixed income research, macroeconomic research and quantitative analysis, which are used internally and externally to advise clients.
Size is an asset in the investment banking business, where the largest investment banks rely on the world to find buyers and sellers.
The disadvantage of investment banks.
Investment banks advise outside clients in one branch and trade their accounts in another. Herein lies a potential conflict of interest.
To prevent this, investment banks must maintain what is known as a “Chinese wall” between branches. This figurative barrier is designed to prevent the exchange of information that would allow one side or the other to profit unfairly at the expense of their own clients.