Primer on Investment Banking
Investment Banking:
Investment banking is an umbrella term for many services that an investment bank provides to companies like underwriting, financial advisory services, research, funding, sales and trading activities and managing assets of the companies. Investment Banks generally deal with institutional clients and wealthy individuals.
Sales and Trading: The primary purpose of an investment bank is to “make market” by buying and selling financial products. The “Sales team” of an investment bank is associated with selling financial products and trading strategies to institutional and high net worth private investors. Sales people communicate clients’ order to the appropriate “trading desk”, which will then execute the order per specific requirement of the client.
Proprietary Trading is the trading activity that bank undertakes on its own account. “Prop desk” people do not interface with clients but they trade heavily on banks own money. This kind of trading can be done and is usually done in stocks, bonds, currencies, commodities, derivatives etc.
Research: Two categories of research are Equity Research (Stock) and Fixed Income Research (Bonds). Research analyst reviews the company for its financial strength and ability to meet its obligations and promises. Each analyst covers 10-15 companies in a particular industry segment or sub-segment. The aim of the equity research undertaken on a company is to come up with a fair price of the company share. Depending upon the prevailing market price, the analyst will issue “Buy”, “Hold” or “Sell” rating. Fixed income research, deals with corporate bonds, though the considerations are almost similar as in equity, however, there is a little difference in the approach to accommodate the differences in the characteristics of the instruments i.e., debt vs. equity.
Bank makes money by publishing these researches and selling them for a price. Research analysts also advise high net worth clients on investments.
An investment bank may be involved in providing both advisory services and conducting research on a company for example, same investment bank may be lead underwriter for a company’s next public issue and the company may also covered by bank’s research analyst. As is suspected there is possible situation for conflict of interest. In absence of regulations, research will issue high recommendations for the issue that is underwritten by the bank. To avoid such situation there are strict regulations and a “Chinese Wall” is put up between research and advisory services desks of the bank i.e. there is no communication in any way between these two businesses. Investment banks follow these regulations religiously without any fail.
On the basis of what kind of employer employs the analysts, research could be “Buy-side” or “Sell-side”.
Buy-side analysts are usually employed by mutual funds, hedge funds, pension funds, etc. The objective with which buy-side analysts undertake research is to determine how promising investment in a particular company will be and how it fits the investment strategy and goals of the money manager. The analysts hired are paid for by the fund and these researches are not generally available for use by other parties.
“Sell-side” analysts work for brokerage firms, involved in managing individual accounts and issue recommendations regarding the performance of the stock or bond they are covering. The purpose of the research is to help their clients make knowledgeable decision to buy or sell a security.
Financial Advisory Services:
An investment bank is involved heavily in financial advisory services. Investment banks give companies advice on mergers and acquisition, when and how capital should be raised, tracking the market for the best possible time to offer an IPO or secondary offering etc.
Apart from advisory services, investment bank operates extensively in Capital Markets arena. The term capital markets, relates to equity and bond markets, both domestic and international, as well as cover derivatives and other financial instruments. Over years with development of securitization and derivatives market a whole new segment of Structured Transaction has surfaced in investment banking business.
To work in research and financial advisory services area of Investment Banks, one requires expertise in excel based financial modeling and valuation. Though, a job in capital market groups will require in-depth knowledge of functioning of capital markets, analytics of various financial instruments like convertible securities, derivatives etc and excel based modeling skills.
There are certain other banking related activities that might be undertaken by an investment bank itself or by firms specializing in these areas, for example Private Equity, Venture Capital etc.
Private Equity:
Private equity implies equity investment in companies that are not traded publically. Private equity investment may be in the form of Leveraged Buy-Outs, Venture Capital or Distressed Financing.
Private Equity capital is very risky investment with huge payout potential. However, each kind of private equity investment has different risk return profile.
In case of leveraged buyouts, private equity fund buys a large portion of a publically traded company and takes it private, turns it around by taking over management and a complete operational overhaul. The investment horizon is generally 5-9 years, at the end of which company is taken public again and the private equity fund gets it investment back along with huge returns.
About Ascent Financials: Ascent Financials is an effort to provide quality finance education to students who want to build a career in finance. The firm is a brainchild of ex-Wall Street investment bankers and renowned academicians. We provide coaching classes for SFM Final and post qualification programs in the field of finance.
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