Functions of Investment Banking
Investment Banks performs various different type of function in the economy by offering different financial services to their clients such as helping the corporations in finding the investor for obtaining the debt finance, underwriting of the stock issues, working as the financial advisor, handling of the mergers and acquisitions etc.
An investment bank is like a middleman between investor and issuer and helps their client to raise money through debt and equity offering. Some of the investment banks are JP Morgan Chase, Goldman Sachs, Credit Suisse, Morgan Stanley, etc.
It provides all types of financial services. Below listed are the top 7 investment banking functions –
There are multiple Investment banking functions, and they are as follows:-
#1 – IPOs
This investment banking function, i.e., IPOIPOInitial Public Offering (IPO) is when the shares of the private companies are listed for the first time in the stock exchange for public trading and investment. This allows a private company to raise the capital for different purposes. is an initial public offering wherein a company hires an investment bank to issue IPO.
Below are the steps followed by a company for its IPO:-
- Before the issuance of IPO company hire an investment bank. This bank is chosen based on different criteria like market reputation, industrial experience, quality of research and distribution channels, etc.
- Selected banks so underwriting Underwriting The underwriters take the financial risk of their client in return of a financial fee. Market Makers like financial institution and large banks ensure that there is enough amount of liquidity in the market by ensuring that enough trading volume is there.where it acts as a broker between investors and issuing company.
- The investment bank works out on financial detail of the IPO in the underwriting agreement.
- Post that company files registration statement along with underwriting agreement with SEC.
- Post-approval of IPO by SEC underwriter and issuing company decide offer priceOffer PriceOffering Price is the price that is decided by an investment banking underwriter when a company plans to go public list shares in the stock exchange for raising capital. This price is based on the future earning potential of the company, however, the price shouldn’t be too high then the shares might not be sold in full and if it is too low then the potential to raise more capital is lost. and a number of shares to be sold.
- After issuance, the bank carries out aftermarket stabilization in which that bank analyzes aftermarket stabilization and creates a market for the stock.
- The final stage is a transition to market competition. After 25 days period, the bank provides an estimate regarding the valuation and earning of the issuing company.
Investment bank helps a company to set everything and list IPO in a stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.. IPO is one of the major investment banking functions. This bank, in return, charges a commission from a company.
#2 – Merger and Acquisitions
Merger and Acquisitions is the area of corporate finances, management, and strategy dealing with purchasing or joining with other companies. An investment bank, in return, charges fees for M&A. M&A company hires a bank for mergers and acquisitions. The following steps are taken for M&A by investment banks.
- There are two types of roles in M&A of an investment bank; they are seller representation or buyer representation.
- A critical role in M&A is the valuation of a company. The bank calculates the actual value of a company.
- Investment bank builds its strategy for M&A of two companies.
- The investment bank also does financial provisioning for a company as for M&A company will need lots of funds. It helps a company in raising funds for M&A.
- The main role of a bank is to issue new securities to the market.
This investment banking function helps a small firm to project itself, design a merger once a suitable target is found. It helps in the success of the merger, and this is all done with the help of an investment bank.
#3 – Risk Management
Risk Management from the name itself, it is clear that its management of risk involves, it is a continuous process as capital is involved, it set a limit to avoid loss in trade. Investment banks help a company in the following ways:-
- Investment bank helps a company to manage financial riskFinancial RiskFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy. in term of currency, loans, liquidity, etc.
- This bank helps a company to recognize the loss area.
- This credit risk control credit risk investment spreads out counterparties, and banks choose standard exchange for trading.
- There are different risks like business riskBusiness RiskBusiness risk is associated with running a business. The risk can be higher or lower from time to time. But it will be there as long as you run a business or want to operate and expand., investment risk, legal & compliance risk, and operational risk, which are internally controlled by an investment bank.
Risk management is done at every level by investment banks as it highlights what the risks are and how it can be handled.
#4 – Research
This equity research investment banking function is one of the most important investment banking function is research. This research helps provide a rating to the company to help investors to make a decision of investment. Research reports tell whether to buy, sell, or to hold the base on a rating of a company. Through this, one can know the worthiness of the company. Research is done by analyzing and comparing various reports and performance reports of the company. Investment bank primary work is research, and these researches are of multiple types like equity researchEquity ResearchEquity Research refers to the study of a business, i.e., analyzing a company's financials, performing Ratio Analysis, Financial forecasting in Excel (Financial Modeling), & exploring scenarios to make insightful BUY/HOLD/SELL stock investment recommendations. Moreover, the Equity Research Analysts discuss their findings & details in the Equity Research Reports. , fixed income research, macroeconomic research, qualitative research, etc. Investment bank shares these reports with clients which helps an investor to generate profit through trading and sales.
#5 – Structuring of Derivatives
For this Investment banking function, i.e., structuring of derivatives, investment bank needs a strong technical team working on such a complex structure of derivatives. Derivatives product offer a high rate of return and good margin; hence a lot of risks is involved with it. Investment bank prepares these derivatives with a strategy based on a single as well as multiple securities.
This bank adds features to it, like in bonds. It provides future and options derivative etc. Investment bank designs securities with different derivatives options. The main reason to design such a product is to attract investors and to increase the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. .
There is another derivative also available in the market; it helps to generate a good return to investors.
#6 – Merchant Banking
This investment banking function is one of the private activities of the investment bank where the bank also does consultancy for their clients. They provide consultancy in a matter of financial, marketing, legal, and managerial. It acts as a financial engineer for business.
Merchant bankingMerchant BankingMerchant Bank is a company that provides services like fundraising activities like IPOs, FPOs, loans, underwriting. They only deal with companies and businesses. has the below functions:-
- Raising finance for a client
- Broker in Stock exchange
- Project management
- Money market operations
- Leasing service
- Portfolio management
- Handling government consent for industrial projects
- Managing public issue of a company
- Special assistance to small companies and entrepreneurs
There are multiple other services provided by investment banks to their clients. This bank charges consultancy fees from investors.
# 7 – Investment management
This investment banking function is a core job of an investment bank to guide the investor to purchase, manage his portfolio, and to trade various securities. Investment bank prepares reports based on company performance, and through this it investment bank makes a decision on financial securities. Investment advice is provided based on the client’s objective, the client’s risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation., investment amount, and time period. Based on the customer segment, investment management is divided like Private clients, Private wealth management, wealth management. Here, an investment bank manages a portfolio of customers and also provides tips to investors whether to sell stocks or to buy stocks or to hold stocks.
This has been a guide to Investment Banking Functions. Here we discuss the top 7 functions of Investment Banking, including IPOs, M&A, Research, Risk Management, Structuring Derivatives, Investment Banking, and more. You may also take a look at below articles related to investment banking-