Investment Banking

Investment banking is the provision of services to businesses and governments in obtaining money, usually through the sale of marketable securities. These securities are usually stocks or bonds. Common or preferred stocks, or shares, sometimes called equities, are sold to investors, who become owners of a part, or share, of the business. Bonds are borrowings and are sold to investors, who then become creditors of the business or government. Many varieties of bonds and stocks are issued to obtain money, called capital.

When new securities are sold by an issuer, the transaction is a primary sale, and the money goes to the issuer. When a security holder sells a stock or bond, the transaction is a secondary sale. In a secondary sale, the money goes to the former security owner, not to the business or government issuer. Investment bankers may be asked to manage large secondary as well as primary transactions.

Investment banking is as old as the corporate form of business, Investments banks also called - merchant banks. When profit-seeking companies need capital, they turn to agents, who obtain it for them from savers. Traditionally, those savers were individuals, but they are now more likely to be financial institutions, such as insurance companies, private or government pension funds, or mutual funds.

Instead of obtaining money through a public sale of securities, investment-banking agents sometimes obtain it directly through a private sale to one or several institutions. Such private placements may be more flexible or faster than a public offering. For a private placement, the Securities and Exchange Commission (SEC) which oversees U.S. securities markets, does not require a lengthy registration document and prospectus describing the issuer and the security. Development of the "shelf registration" process has made it possible for qualified issuers to get advance clearance from the SEC to permit a quick public sale when market conditions become favorable.

Also majority of investment banks present strategic advisory services for acquisitions, mergers, divestiture, etc. for their clients, such as the trading of equity securities, derivatives, foreign exchange, commodity, and fixed income.

Investment banks meet their expenses and earn a profit by charging a commission, called the underwriters' spread, on the funds they raise. The commission may be as low as 1% on a goodsized bond issue for a state, or as high as 15% for a new business selling common shares in an initial public offering.

Investment banks usually guarantee, or underwrite, that they will raise the the needed capital whether or not the securities are sold to savers at the initial price. Underwriting is sometimes called buying, because the investment banks buy the securities for resale. In the case of highly speculative issues, investment bankers may agree only to make their best efforts to raise the capital. Such "best efforts" transactions are not underwritten.

A managing investment bank, frequently called the managing underwriter, oversees the security issuance process. This firm offers advice to the issuer about the amount of money to be raised, the nature of the securities to be issued, and the timing of the issue in view of market conditions. The managing underwriter selects the firms that will share the risk of underwriting the issue. It also selects the firms - some of which may be in the underwriting syndicate that will distribute or sell the securities.

The managing underwriter receives a share of the commission that is earned on an entire securities offering, whereas members of the underwriting or selling syndicates are compensated only on the securities that they underwrite or sell. Because of the revenues and power that are associated with the managing underwrite role, investment bankers often compete intensely for the position.

Instead of negotiating with a managing underwriter, an issuer will occasionally invite bids from prospective underwriters, who form syndicates to compete for a particular security issue. The issuer sells the securities to the syndicate that offers the best terms. Security offerings by states, municipalities, and regulated public utilities are often handled in this manner.

Pricing a security is a challenging task. If a security is priced too high, it will not sell, causing the underwriters to suffer a loss. If a security is priced too low, it may rise quickly in price within a secondary market, denying the issuer just compensation for the security. Most investment banking firms have allied brokerage and market-making businesses that provide insight into appropriate security prices. As brokers, they constantly buy and sell securities on behalf of clients. As market makers, they establish prices by buying and selling securities for their own accounts.

In order to facilitate the selling of a large new issue, a managing underwriter will attempt to stabilize the price by announcing its willingness to buy at the offering price on the secondary market any of the new securities that recent buyers have decided they would rather not hold. Initially, underwriters may sell more than the allocated number of securities in order to ensure that they have some buying power to repurchase these shares.

Investment bankers offer many services to their clients. They often help clients find companies to buy in friendly or unfriendly acquisitions. They counsel ompanies that have been targeted for unfriendly takeovers. They may sell novel securities, such as "high-risk, high-interest-rate" bonds (called junk bonds). They also make investments with their own capital, acting in the manner of European merchant bankers.

The trend toward merchant banking and more complex business operations has led the majority of investment-banking houses to obtain additional capital by going public and selling shares to outsiders. As the financial strength of these firms has grown, some have even been able to underwrite and sell large issues without the help of other firms.

Investment bankers have also created new securities to help their client better manage investment risks and returns. These include securities derived from collections of mortgages and from stock market indexes. Investment bankers help their clients exchange obligations through complex swap arrangements that affect the maturities, costs, and sometimes even the currencies of these obligations. Following the globalization of the securities market, investment bankers have opened offices worldwide.

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