Investment Banking

What Is Investment Banking?

Investment banking is a specific division of banking that many people struggle to understand. In this article, we’ll dive deep into the topic of investment banking. We’ll cover the definition of the term, break down investment banking for you, and talk about the role of investment bankers in the financial world.

Understanding Investment Banking

As mentioned earlier, investment banking is a specific division of banking. It is related to the creation of capital for companies, governments, and other entities. Investment banks work specifically with the following financial transactions for all types of corporations:

  • Underwriting new debt and equity securities
  • Aiding in the sale of securities
  • Helping to facilitate mergers and acquisitions, reorganizations, and broker trades for institutions and private investors
  • Providing guidance to issuers regarding issue and placement of stock

Most large investment banks are affiliated or smaller divisions of larger banking institutions. For example, Morgan Stanley, JPMorgan Chase, Bank of America, Merrill Lynch. At the most basic level, investment banking deals with large, more complicated financial transactions. It helps large corporations or wealthy individuals successful execute mergers, sales, and acquisition transactions.

The Role of Investment Bankers in the Financial World

Investment bankers work with investment banks to help corporations, governments, and other large financial projects make the right moves. They manage large financial transactions and identify risks associated with the projects before a client moves forward. When it comes to large financial transactions, investment bankers are experts on what is the right step for businesses and individuals to achieve financial success.

Investment bankers look at the client, the potential transaction, and the present state of economic affairs before they advise. They have extensive training and education in the financial world. They also have years of experience with this type of financial transactions. Investment bankers are the middle man between companies and investors. They assist with issue stocks or bonds, pricing financial instruments to maximize revenue, and navigating regulatory requirements.

Example of How Investment Bankers Buy and Sell

Here’s an example of how investment banking works:

Rob’s Restaurant Supply is a chain that supplies commercial restaurant supplies and he wants to go public. Rob, the owner, gets in touch with Dave, an investment banker at JPMorgan Chase. Rob and Dave meet. They strike a deal where Dave agrees to buy 100,000 shares of Rob’s Restaurant Supply for the company’s IPO. He purchases the shares at a price of $44 per share. For 100,000 shares, Dave pays $4.4 million. After the deal is complete, Dave turns around and sell the stocks for $46 per share.

In many cases, investment bankers overvalue shares. They might sell a certain number of shares at a higher price but will need to reduce the price to unload the rest. For example:

Dave is able to successfully sell 20% of the shares at $46 per share. But, he can’t sell the rest at that price. He has to reduce the price to $43 per share to sell the remaining 80%. Therefore, the investment bank loses some money on the deal. But, Rob’s Restaurant Supply makes money in the deal.

Dave originally spent $4.4 million on the shares. He sold 20,000 at $46 per share, totaling $920,000. The remaining 80,000 shares were sold at $43 per share, totaling $3.44 million. So, Dave made $4.36 million off the deal, but he lost $40,000.

While investment banks may occasionally lose money in transactions, they absorb these losses much better than the companies they serve. If you are a wealthy investor or own a large corporation, investment banking is the best way to make successful financial transactions for your business.

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