Essay: Investment Banking

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  • Published on: August 12, 2017
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Do you want to make money out of money? If yes, then the solution is Investment bank. To be precise, Investment bank is nothing but a bank which matches the expectations of people having the capital with people who need the capital. 1

It is a financial intermediary that specializes primarily in selling securities and underwriting the issuance of new equity shares to raise capital funds. This is different from a commercial bank, which specializes in deposits and commercial loans. It assists individuals, corporations, and governments in raising financial capital by underwriting or acting as the client’s agent in the issuance of securities. An investment bank may also assist companies involved in mergers and acquisitions (M&A) and provide ancillary services such as market making, trading of derivatives and equity securities and FICC services (fixed income instruments, currencies, and commodities). Unlike commercial banks and retail banks, investment banks do not take deposits.

When a company or other organization wants to raise funds, it frequently does so by issuing and selling new securities, such as stocks or bonds. An investment bank usually helps in this process by providing expertise and customers to buy the securities. A company does not need to use an investment bank, but it usually does, because it is less costly than trying to issue and sell securities directly to the public.

An investment bank is not a bank in the usual sense. It doesn’t offer bank accounts like savings or recurring ones, nor does it make loans. In simpler terms, it is a bank which helps businesses, governments, and agencies to get financing from investors. The same thing done by regular banks is by way of lending the deposited money of Accountholders. In other words, Investment banks act as a financial intermediary for businesses and other large organizations, connecting the need for money with the source of money. In fact, the term “investment bank” is something of a misnomer. In many cases, helping companies raise capital is just one part of a much bigger operation.

Concept of Investment Banking

The main concept behind which an Investment bank revolves is to match the gap between a need of capital and availability of capital along with again matching the gap between advice seekers(client) and Advice givers(the bank).By and large, Investment banks in India are itself an institution which generates funds either by drawing public funds via the capital market or by way of venture capital or private equity.

Role of an Investment bank

As an advisor

Raising capital

Raising capital is always an important function for any business and so deciding how to raise it becomes very crucial for any company. It is the Investment bank which provides the tailor made solution. At the macro level, investment bank performs the primary function of assisting the capital market in its function of capital intermediation, i.e., the movement of finance from the investors to issuers. The sale of stocks and bonds is one of the primary ways for a company to raise capital. But executing these transactions requires special expertise, from pricing financial instruments in a way that will maximize revenue to navigating regulatory requirements. That’s where an investment bank usually comes into the picture.

Taking into account the current investing climate, the bank will recommend the best way to raise funds. This could entail selling an ownership stake in the company through a stock offer or borrowing from the public through a bond issue. The investment bank also helps to determine the pricing of these instruments. In the case of a stock offering, its financial analysts will look at a variety of different factors – such as earnings potential and the strength of the management team – to estimate how much a share of the company is worth. If the client is offering bonds, the bank will look at prevailing interest rates for similarly rated businesses to figure out how much it will have to compensate borrowers. They also track the market to determine the time of public offering and to explore the best possible way of managing the public assets of businesses. Many a times such a role seems to overlap with that of a private brokerage house.

It is very hard to demarcate a line between the investment banking and other forms of banking in India as all the banks nowadays besides their normal functions also tend to play the role of Investment bank.

Over the decades, investment banks have proved their worth by fulfilling the needs of the finance community and thus have became one of the most vibrant and exciting segment of financial services. In essence, investment banks are a bridge between large enterprises and the investor. Their main roles are to advise businesses and governments on how to meet their financial challenges and to help them procure financing, whether it be from stock offerings, bond issues or derivative products.

Merger or acquisition

The major role played by investment banks is in the field of consultancy. Investment banks also offer advice in a merger or acquisition scenario. For example, if a business is looking to purchase a competitor, the bank can advise its management team on how much the company is worth and how to structure the deal in a way that’s favorable to the buyer.Their main task is to help in organising mergers, helping target companies to develop and implement defensive tactics, helping in valuing the target company, helping in financing mergers and investing in stock of firms which are likely to merge. These M& A services are a huge source of profit for these Investment bankers.

Underwriting stocks and bonds

If an entity decides to raise funds through an equity or debt offering, one or more investment banks will also underwrite the securities. This means the institution buys a certain number of shares – or bonds – at a predetermined price and re-sells them through an exchange.

Other activities

While advising companies and helping them raise money is an important part , most Investment banks perform a number of other functions as well. In fact, most major banks are highly diversified in terms of the services they offer. Some of their other income sources include:

Research – Larger investment banks have large teams that gather information about companies and offer recommendations on whether to buy or sell their stock. They may use these reports internally but can also generate revenue by selling them to hedge funds and mutual fund managers.

Trading and Sales – Most major firms have a trading department that can execute stock and bond transactions on behalf of their clients.

Asset Management – The likes of J.P. Morgan and Goldman Sachs manage huge portfolios for pension funds, foundations and insurance companies through their asset management department. Their experts help select the right mix of stocks, debt instruments, real estate trusts and other investment vehicles to achieve their clients’ unique goals.

Wealth Management – Some of the same banks that perform investment banking functions also cater to everyday investors. Through a team of financial advisors, they help individuals and families save for retirement and other long-term needs.

Securitized Products – These days, companies often pool financial assets – from mortgages to credit card receivables – and sell them off to investors as a fixed-income products. An investment bank will recommend opportunities to “securitize” income streams, assemble the assets and market them to institutional investors.

How it works

Investment bank act as a
mediator between companies issuing securities and the buyer individuals or entities. In this respect, Investment banks operate along two main lines: a “buy” side and a “sell” side. “Buy” side operations include services such as securities trading and portfolio management. For eg. suppose an investor wants to purchase 100 shares of company XYZ. They can solicit the services of an investment bank, where a stock broker can place an order and deliver these shares.

“Sell” side activities include underwriting new lines of stock, marketing financial products, and publishing financial research. It involves trading securities for cash or for other securities. For example company XYZ plans to issue new shares of stock in an initial public offering (IPO) XYZ can solicit an Investment bank to underwrite the shares, market and sell them to their clients. This way, the investment bank raises the funds that company XYZ hopes to gain from the issue of the new shares.

Organizational structure

Front office

As far as revenue generation is concerned, it is the Front office of any Investment bank.This front office can be divided between two main areas if Investment banking which involves advising on mergers and acquisitions, as well as a wide array of fund raising strategies and markets which is divided into “sales and trading” (including “structuring”) and “research”.

Middle office

The middle office of the bank includes treasury management, internal controls and internal corporate strategy.

Corporate treasury is primarily responsible for an Investment bank’s funding, capital structure management and liquidity risk monitoring.

Internal control tracks and analyzes the capital flows of the firm, the finance division is the principal adviser to senior management on essential areas such as controlling the firm’s global risk exposure and the profitability and structure of the firm’s various businesses via dedicated trading desk product control teams.

Internal corporate strategy tackling firm management and profit strategy, unlike corporate strategy groups that advise clients, is non-revenue regenerating yet is having a key functional role within investment banks.

Back office

Although many Investment banks use to outsource it, but the back office remains a critical part of the bank involving data-checking trades to ensure their correctness and transacting the required transfers.

Technology

Every major Investment bank has considerable amounts of in-house software, created by the technology team, who are also responsible for technical support. Technology has changed considerably in the last few years as more sales and trading desks are using electronic trading. Some trades are initiated by complex algorithms for hedging purposes.

Big foreign players in Indian Investment banking sector –

Many foreign investment banks are set up in India, so the banking sector in India becomes more competitive. Following are list of top investment banks in India.

-ABN-AMRO Bank

-Nomura

-The Bank of New York Mellon

-BNP Paribas Bank

-Citi Bank

-Deutsche Bank

-HSBC

-JPMorgan Chase Bank

-Goldman Sachs

-Morgan Stanley

-Barclays

List of Top Indian Investment Banks

-Bajaj Capital

-Avendus

-ICICI Securities Ltd

-Kotak Mahindra Capital Company

-SBI Capital Markets

-Yes Bank

Regulatory Framework for Investment Banking in India2

Investment Banking in India is regulating in its various facets under separate legislations or guidelines issued under statute. The Regulatory powers are also distributed between different regulators depending upon the constitution and status of Investment Bank. Pure investment banks which do not have presence in the lending or banking business are governed primarily by the capital market regulator (SEBI). However, Universal banks and NBFC investment banks are regulated primarily by the RBI in their core business of banking or lending and so far as the investment banking segment is concerned, they are also regulated by SEBI. An overview of the regulatory framework is furnished below:

-At the constitutional level, all invest banking companies incorporated under the Companies Act, 1956 are governed by the provisions of that Act.

-Investment Banks that are incorporated under a separate statute such as the SBI or IDBI are regulated by their respective statute. IDBI is in the process of being converted into a company under the Companies Act.

-Universal Banks that are regulated by the Reserve Bank of India under the RBI Act, 1934 and the Banking Regulation Act which put restrictions on the investment banking exposures to be taken by banks.

-Investment banking companies that are constituted as non-banking financial companies are regulated operationally by the RBI under sections 45H to 45QB of Reserve Bank of India Act, 1934. Under these sections RBI is empowered to issue directions in the areas of resources mobilization, accounts and administrative controls.

-Functionally, different aspects of investment banking are regulated under the Securities and Exchange Board of India Act, 1992 and guidelines and regulations issued there under.

-Investment Banks that are set up in India with foreign direct investment either as joint ventures with Indian partners or as fully owned subsidiaries of the foreign entities are governed in respect of the foreign investment by the Foreign Exchange Management Act, 1999 and the Foreign Exchange Management (Transfer or issue of Security by a person Resident outside India) Regulations, 2000 issued there under as amended from time to time through circulars issued by the RBI.

-Apart from the above specific regulations relating to investment banking, investment banks are also governed by other laws applicable to all other businesses such as – tax law, contract law, property law, local state laws, arbitration law and the other general laws that are applicable in India.

Project Finance3

Project Finance is an age old form of financing high-risk, development-oriented projects and is one of the key focus areas in today’s world because of continuous growth and expansion of the industries at a rapid rate.

It is the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project. In other words, it can also be said as a loan structure that relies primarily on the project’s cash flow for repayment, with the project’s assets, rights, and interests held as secondary security or collateral. Project finance is especially attractive to the private sector because they can fund major projects off balance sheet. They are most ordinarily non-recourse loans, which are fortified by the project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness of the project sponsors, a decision in part braced by financial modeling.

Methods of Project Financing

The various sources of finance can be broadly divided into two categories, viz. equity capital and debt capital (borrowed capital),namely the Share capital ,Term loan, Debenture capital, Commercial banks and Bills discounting. The combination of equity and debt
should be judiciously chosen, and it varies according to the nature of the project.

Some other financing are Seed Capital which is an assistance given by way of long term interest free loan. It is provided to small as well as medium scale units promoted by eligible entrepreneurs.Along with this subsidies are also important source of finance, drawn-out by the Central as well as State Government.

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