Investment Banking

What is Investment Banking?

Investment banks are the specialized institutions engaged in providing assistance to the commercial organizations and companies in raising their long-term capital through the sale of shares, stocks and bonds in the open market. Unlike commercial banks these institutions work primarily as middlemen between the corporate bodies and the investing public. Generally, they take the whole issue of new shares of the business corporations or of other bodies. Subsequently they reissue them to the public at a higher price. Sometimes they also act as agents on commission basis. But usually they underwrite the issue of securities.

Classification of Investment Banks

Investment banks may be classified as: (a) Originators, (b) Underwriters and (c) Retailers. As Originators, their task is to bring out the new issue of the securities. As underwriters, however, they undertake to buy up the entire issue if not subscribed or responded to by the investors. On the other hand, as retailers, they arrange the sale if the securities to the individuals and institutional investors. They may also arrange private placement of the shares through negotiation. All these functions may be performed separately or single institutions may also do all the jobs depending on the market situation.

Mechanism of Operation of Investment Banking

The investment bankers as Originators conduct the preliminary negotiations with the issuing company or corporation. They obtain from them the detailed reports on the background of the issuing corporation, its corporate powers, the description of its products, the valuation of plant and machinery and other assets, its ownership and capital structure, and the purpose of the new issue etc. Generally they get these reports verified by the experts, technicians, professionals and accountants. They also obtain legal opinion on the legality of the issue.

If the details favorable, the Originator comes into an agreement with the issuing company y or corporation agreeing to bring out the new issue. If the issue involves large amount the Originator requests other investment banks to join an ‘underwriting syndicate’. This syndicate acts as a selling group. Finally, the securities are offered for public subscription. Simultaneously, the Originator takes various steps to avoid any possible glut in the market prices of the securities. He generally leaves an “Open Order” to repurchase the securities. In this case the price is kept slightly below the price at which they are offered to the public.

Usefulness of Investment Banking

Investment bank renders highly useful services to the business and industry by providing the necessary capital for meeting the long-term needs. Considering this importance, it is frequently called the “entrepreneur of entrepreneurs”. On the other hand, the investing public is also immensely benefited by the activities of the investment banker. The independent and in depth analysis of the stock made by the investment banker gives an idea to the investors about the desirability of the shares. This helps the investors to make their decisions as to whether the shares can be brought or not.