The investment bank is a financial institution that deals in stocks and bonds for companies and provides other financial services such as assisting in mergers and acquisitions, managing retirement funds, financial advisory, and payment solutions.
Definition and Examples of Investment Banks
An investment bank is a financial institution that specializes in meeting the needs of commercial clients. A typical investment bank may be capable of performing some or all of the following tasks:
- Raising equity capital
- Raising debt capital
- Underwriting securities or assisting in launching new products
- Participating in private trading. Teams of specialized money managers can invest or trade the firm’s money on their own account.
- Providing advice or services in mergers and acquisitions
- Providing payment and transaction services
- Researching and developing solutions for tough financial issues
For example, let’s assume that XYZ Manufacturing Company wants to sell $10 billion in bonds so it can build new factories in Asia. The investment bank will help it find buyers for the bonds and also handle the securities; this will be done in collaboration with a team of lawyers and accountants.
Investment banks can also assist in initial public offerings (IPOs), where a private company transitions from private ownership to public ownership and becomes listed on the stock exchange.
Notable investment banks include financial institutions such as Goldman Sachs, Bank of America, and Citigroup.
How Do Investment Banks Work?
Investment banks are often divided into two groups: the buy side and the sell side. However, many of them offer services from both the buy side and the sell side. The sell side of the bank is involved in selling shares of new public offerings, placing new bond issuances, engaging in market-making services, or helping clients facilitate transactions.
In contrast, the buy side of the bank generally works with pension funds, mutual funds, hedge funds, and individual investors. The aim is to help them achieve maximum returns on investment when trading or investing in securities such as stocks and bonds.
Many investment banks are divided into three divisions, based on the services provided and the responsibilities of staff:
- Front office
- Middle office
- Back office
Front office services typically include:
- Assisting companies with mergers and acquisitions
- Corporate finance (such as issuing billions of dollars in commercial paper to aid in funding daily operations)
- Professional investment management for institutions or high-net-worth individuals
- Commercial banking
- Providing research reports and developing solutions for tough financial issues
The middle office in investment banks includes investment banking services like compliance with regulations and governmental restrictions for professional clients such as banks, insurance companies, and finance departments, as well as capital flows.
Work teams that monitor the money coming in and out of the firm help determine the amount of liquidity the firm needs to maintain a secure financial hand so that it does not face financial problems. A capital flow team can use that information to restrict trading by reducing the buying and trading power available to other departments.
Back office services involve the core functions of the investment bank, such as ensuring that the correct securities are bought and sold in the right amounts and settled, ensuring that the technology programs and platforms that allow traders to perform their functions are up to date and effective, and creating new trading algorithms.
Back office functions in investment banks are often considered unexciting. Some investment banks outsource them to specialized firms like custodians. However, back office services remain essential to running the entire operation of the bank.
Investment Bank vs. Commercial Bank
Investment Bank vs. Commercial Bank
Does not accept deposits accepts deposits
Does not extend loans extends loans
Targets large companies and high-net-worth individuals targets all consumers, from small to large companies and governments.
It is
It is organized by the country’s Securities and Exchange Commission, while it is regulated by the country’s central bank.
The main difference between an investment bank and a commercial bank is that investment banks focus on helping companies access capital markets. Meanwhile, commercial banks primarily deal with deposit accounts and loans for individuals and small businesses.
Investment banks in the United States have not been allowed to be part of commercial banks since 1933. Banks that offered both investment and commercial services were seen as major contributors to the stock market crash of 1929, as banks could provide both commercial and investment services. However, under a modified version of Section 619 of the Dodd-Frank Act – known as the Volcker Rule – commercial banks can now engage in specific investment activities.
Source: https://www.thebalancemoney.com/what-is-an-investment-bank-357318
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