Investment banking covers a wide spectrum of activities, basically most banking activities other than accepting commercial deposits from customers would come under the purview of investment banking.
Bonds and Equity Issues
Issues involve both new issues and rights issues. New issues are first time issues of bonds or equity. Investment banking activities for new issues include pricing the securities, selling them to investors, underwriting and general advice to the parties involved. Underwriting is the practice of the investment banks buying the securities if they cannot be sold to any investors. Of course, substantial fees will be charged for all these activities! Often, several banks perform the underwriting jointly in order to spread the risk – the consortium of banks is called a syndicate. In the case of equities, the underwriters purchase the unsold shares only after it is evident that any investors are not taking it up. On the other hand, in the case of many bond markets, the underwriters buy the issue first and then attempt to sell them to investors.
Rights issues are similar to new issues – the key difference being that in the case of rights issues, there are already shares of the company in the market i.e. there are existing investors, and the company wants to issue more of the same. In this case, there are laws and regulations in place to ensure that the existing shareholders get the first rights to purchase the new issue often at a discount. The investment banking activities associated with a rights issue is similar to a new issue.
Mergers and Acquisitions
Mergers and Acquisitions are the mainstay of investment banking. Mergers, as the name suggests are the coming together of two or more companies and acquisition is the taking over of one company by another. In both these activities, the advisory role of investment banks is paramount and there are hefty fees involved. Due to the often acrimonious nature of these activities an interesting set of phrases has come to be associated with them.
If a takeover is looming, the target may try to find a rival bidder who is preferable to the original predator. This more acceptable candidate is called the ‘White Knight’. Sometimes a few people can be found who will take a small stake in the company and block the takeover – these are the ‘White Squires’. Sometimes, the ‘White Squire’ may become a ‘Trojan Horse’ meaning he tries to take over the company himself! If you remember the old computer came, you may be interested to hear about the ‘Pac-man defense’ where the company being taken over turns around and gobbles up the monster trying to take it over! Sometimes, the bidder may be forced to withdraw by the target who buys back the price at a higher price. This is called ‘greenmail’ as opposed to blackmail. In the US, a legal provision provides for a popular defense against hostile takeover bids. Called the ‘poison pill’, it allows the target company to give all existing shareholders the right to buy new shares are a large discount, thus diluting the stake of the bidder considerably.
Securities Trading
Investment banks usually have a separate trading wing in which they invest in securities by trading. Trading may be on behalf of their clients or for the firm itself – called ‘Proprietary Trading’. Usually, there are different departments dealing with different types of securities like bonds, equity, derivative products, commodities etc.
Investment Management
Lastly, investment banks often manage clients’ money on their behalf. The reason some clients opt to let investment banks manage their money is that the banks are likely to get higher returns on investment than the average investor. These clients may be private individuals, in which case banks usually stipulate that they’re net worth must be above a certain value (high net-worth individuals) or corporate institutions.
Some banks have both an investment banking side as well as commercial banking interests. In this case, it’s important that the interests of clients of the bank are put ahead of the profit making strategies of the bank. All countries have regulations in place to separate the commercial and investment banking activities to ensure this.
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