Principal Functions of Investment Banks

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. For 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

In short the principal functions of investment banks include:

  1. Raising Capital
  2. Brokerage Services
  3. Proprietary Trading
  4. Research Activities
  5. Sales and Trading

1. 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.

2. Brokerage Services

Brokerage services, typically involves 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.

3. Proprietary Trading

Under investment 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 make 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 profit for itself by engaging in trading activities.

4. 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.

5. 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 is 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.

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