Investment Banks: This is because of the profit motive as a result of which all companies have to do something to increase their portfolios and get better funds as well. Learn Investment Banks with their Principle and Functions; A lot of this comes in the form of bonds, stock transfer etc. but the biggest contribution is made through investments. Investment banking is a post that helps companies get these investments.
Here are explained; What is Investment Banks? with their Principle and Functions.
Investment banking is a field that involves many levels of division of work. The investment banking advice given would differ in different stages, from the smaller levels of the organizations to the higher levels. The magnitude of the advice given would vary with the level, of course. The clients are to be advised on matters of business, especially financial.
Issues relating to mergers, acquisitions, bonds, strategies regarding investments, the sale of company stocks to public etc. are also to be discussed. These are the most important financial aspects of running a company and these are the strategies that would determine a company’s success or failure in the future. Global investment banks typically have several business units, each looking after one of the functions of investment banks.
For example, Corporate Finance, concerned with advising on the finances of corporations, including mergers, acquisitions and divestitures; Research, concerned with investigating, valuing, and making recommendations to clients – both individual investors and larger entities such as hedge funds and mutual funds regarding shares and corporate and government bonds; and Sales and Trading, concerned with buying and selling shares both on behalf of the bank’s clients and also for the bank itself.
Investment banks management of the bank’s own capital, or Proprietary Trading, is often one of the biggest sources of profit. For example, the banks may arbitrage stock on a large scale if they see a suitable profit opportunity or they may structure their books so that they profit from a fall in bond price or yields.
#Principal Functions of Investment Banks:
The principal functions of investment banks include:
- Raising Capital.
- Brokerage Services.
- Proprietary Trading.
- Research Activities, and.
- Sales and Trading.
Now, explain;
Raising Capital:
Corporate finance is a traditional aspect of Investment banks, which involves helping customers raise funds in the capital market and advising on mergers and acquisitions. Generally, the highest profit margins come from advising on mergers and acquisitions.
Investment bankers have had a palpable effect on the history of American business, as they often proactively meet with executives to encourage deals or expansion.
Brokerage Services:
Brokerage services typically involve trading and order executions on behalf of the investors. This in turn also provides liquidity to the market. These brokerages assist in the purchase and sale of stocks, bonds, and mutual funds.
Proprietary Trading:
Underinvestment banking, proprietary trading is what is generally used to describe a situation when a bank trades in stocks, bonds, options, commodities, or other items with its own money as opposed to its customer’s money, with a view to making a profit for itself.
Though investment banks are usually defined as businesses, which assist other business in raising money in the capital markets (by selling stocks or bonds), they are not shy of making the profit for itself by engaging in trading activities.
Research Activities:
Research is usually referred to as a division which reviews companies and writes reports about their prospects, often with “buy” or “sell” ratings.
Although in theory, this activity would make the most sense at a stock brokerage where the advice could be given to the brokerage’s customers, research has historically been performed by Investment Banks (JM Morgan Stanley, Goldman Sachs etc).
The primary reason for this is because the Investment Bank must take responsibility for the quality of the company that they are underwriting vis a vis the prices involved to the investor.
Sales and Trading:
Often referred to as the most profitable area of an investment bank, it is usually responsible for a much larger amount of revenue than the other divisions. In the process of market making, investment banks will buy and sell stocks and bonds with the goal of making an incremental amount of money on each trade.
Sales are the term for the investment banks sales force, whose primary job is to call on institutional investors to buy the stocks and bonds, underwritten by the firm. Another activity of the sales force is to call institutional investors to sell stocks, bonds, commodities, or other things the firm might have on its books.
#Functions of Investment Banks:
The following functions below are; Basic functions:
Consultative:
Investment banking is all about financial planning and consultation. After all, this is the primary function of investment banking. The functions of an investment banker who is working as a consultant would involve guiding the companies and providing them with advice on their activities pertaining to investments. Investment banking would also influence a company’s mergers or acquisitions as well.
It involves providing companies with some advice on how they manage public assets and affairs as well. In fact, this is a very strategic field of study and work. The functions of an investment banker might also collide and complement with the works of a private broker who also give advice regarding buying and selling assets to companies, so brokerage and investment banking are related fields.
Transactions:
Investment banking also involves taking practical steps towards achieving what has been advanced on. In larger firms and companies, the functions of investment banking would be limited to an advisory capacity, because the larger firms prefer to contemplate on the advice given and make the decisions themselves.
However, for smaller companies that wish to expand, getting an outside consultant to help out with the implementation of the advice given through investment banking professionals would be a really good option. Smaller companies to require more guidance.
Important Functions:
Bills of Exchange:
This instrument safeguards that a bill is accepted so that control is not lost of the item’s involved. A “bill of exchange” contains a stated date of payment that must be concluded on that date irrespective of any disputes concerning the item named. There are legal measures to prevent payment, termed “non-honoring”, which are subject to different rules depending upon the country involved.
Corporate Finance:
This aspect of investment banking represents a specific finance area that deals with corporate financial decisions as well as the tools and analysis formulas and processes utilized to arrive at these decisions. It is divided into “short-term” and “long-term” techniques and decisions whereby the objective is to enhance corporate value through ensuring the “return on capital” is more than the “cost of capital”. The equation rests on a conservative application of risks.
Corporate finance is related to managerial finance, although the latter is larger in scope as it entails financial techniques that are possible in all business forms, whether they are corporate or non-corporate.
A. IPO’s:
Termed “Initial Public Offerings”, IPO’s represent the beginning of a publicly listed company and as such those investors who are in position at this stage are poised to reap almost immediate gains if the stock rises on opening day. Similarly, these same investors stand to lose money if the opening price drops substantially.
During the last few years, the offering prices have tended to average out as being overpriced. This is borne out by the fact that the closing price, on average, the day of opening generated an annual return of just 2%. In terms of profitability, IPO’s generate large fees for the participating firms and represent the most profitable underwriting area. Fees generally average seven percent (7%).
After the various splits between managing underwriters, brokerage firms, law firms, and staff the profit hovers in the 34% through 40% range. This service is a cornerstone in aiding firms to float securities needed to expand or underwrite operations and as such represents one of the more important functions performed by investment banks.
B. Rights Issues:
These are equity issues whereby shareholders of record have the right to purchase new shares that have a fixed exercise price.
C. Mergers & Acquisitions:
Investment banks act in the capacity as advisors in merger and acquisition deals. In working with both the target’s of acquisition as well as the acquirer’s, investment banks provide their information expertise to help arrive at the “reservation price”. They also calculate the potential for gains and the risks in the transaction.
And while investment banks have a vested interest in these deals, their pragmatism is an effective counterweight in maintaining a balance between undervaluing and overvaluing. Operating under banking regulations, investment banks represent a sort of intermediary that engenders public trust in the legitimacy of the transaction and is a part of a system that represents checks and balances over these types of transactions.
Commercial banks might have potential conflicts of interest in these types of deals, so even while they have recently taken on this role, the majority of these transactions are still funneled through investment banks.
Investment Management:
As the term implies, investment management is also known as portfolio management as well as money management. It is a segment of investment analysis that examines the management of money relating to securities purchases as well as their sale.
A. High Net Worth Individuals:
Investment banking services for individuals of high net worth has been a long-standing feature for an elite group whose banking investment needs exceed the capabilities of commercial banks and traditional specialists. The complex variable regarding the client’s return targets and relative degrees of risk along with long as well as short-term requirements represent specialized analysis.
The resources of an investment bank are suited to meet the demanding requirements of these types of individuals as well as confidentiality. The extremely sophisticated variables comprising recommendations and placement in various instruments are crafted to fit an approved plan of action.
Because high net worth individuals have access to their own channels of information, the demands of these types of clients in terms of sophistication requires the resources of a specialized institution.
B. Corporations:
The investment management of corporations entails handling a number of asset management areas. As is the case with high net worth individuals, it entails an extensive analysis of the goals and objectives desired as well as the cash availability requirements for specific periods of time.
The preceding represents a valuable service as a result of the high-level contacts and access to specialized information, opportunities, and rates of return with the moderate risk that investment banks can avail themselves of.
C. Pension Funds:
These funds represent extremely large sums that require placement in investment avenues that contain high degrees of safety as well as meeting return rates in established parameters.
The important nature of these retirement funds requires an institution to pay close attention to risk avoidance as well as any potential changes and shifts in the market that could potentially affect the money in the Fund.
D. Mutual Funds:
In terms of mutual funds, there are literally hundreds of fund types to select from as a result of the classifications within this group. One particular type of fund which investment banks have an advantage over commercial banks is in hedge funds. These types of funds are unregulated and usually governed by unconventional strategies.
Hedge funds trade in equities, money markets and bonds and offer yields as well as risks that exceed traditional long stock and bond methodologies. The secretive nature of these funds and the fact that they cater to institutions, corporations and high net worth individuals only is within the purview of investment banks.
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