– What do investment banks really do?
In: Economics
It is a bank that specializes in typically large scale project financing. Financing is kind of complicated for an ELI5.
A retail bank typically deals with normal checking and savings accounts, mortgages, small business loans. These are the banks with ATMs and branches etc open to the general public.
A commercial bank might deal with larger companies, handle things like international currencies, lines of credit, letters of credit, escrow services – the day to day cash/liquidity needed for medium to large businesses to operate.
Investment banks tend to handle “special” or “one off” projects usually rather large (10’s of millions to billions) involving very complex legal and regulatory issues, especially deals involving things in different countries (multi national or international deals). These banks consult with customers to provide expert advice, help do financial evaluations and analysis of projects, risk assessments, assist in crafting agreements, arrange for financing (bridge loans, etc). Even large companies seldom have staff with these kind of specialized skills since they are really only needed for big projects. This is where investment banks step in. The big investment bank also brings their reputation to the deal – so if a company engages a reputable investment bank to underwrite a project, it gives assurance to other parties that the deal is credible and the company is being serious.
There are a number of roles they play:
– Advise companies on mergers, acquisitions, public offerings, bond offerings, etc. So they help companies finance buying other companies or internal expansion; help them seek partners to merge or buy them out; they help companies get themselves set financially and prepare to have an IPO and run the offering
– Trading on financial markets, executing trades for clients of all sizes, from bundling trades for small investors to executing billion dollar trades for hedge funds, institutional investors, etc.
– Money management for high net worth individuals. Like you have $10m in assets to invest, and you may have a person at the bank who manages your portfolio for you.
– Retail brokerage services for smaller investors, eg. you set up an account with Merrill Lynch for online trading and they manage the trade executions, etc. on the back-end.
– Proprietary trading, where banks trade their own money/employees’/partners’ money for investment gains.
You’ve spent $10 to invent a new doodad that you know a million people will want and pay $50 for.
You don’t have $10 million dollars to make all those doodads, so I give you $10 million if you agree to give me half of the money from selling all the doodads. Together we spend $10 million, to get $50 million.
We each end up with $20 million from selling all the doodads.
Hi, investment banker here. Banking is the industry of matching people with extra money to people who need money. As a general rule of thumb, think of traditional bankers as dealing with loans, and investment bankers dealing with securities (mostly stocks and bonds).
When companies want to grow, investment bankers help companies find people to buy new stocks and bonds. Investors get the securities, and companies get the money to grow. We take information from the company and use it to create an ‘offering memorandum’ which is basically a powerpoint deck explaining why the company’s stocks or bonds are a great investment. Then, we create a list of people who would potentially be interested in that investment. Then we basically run an auction until the company has sold enough stocks or bonds to meet its goals.
We also help companies do mergers and acquisitions. M&A is basically just buying or selling a majority of the company’s stock to a single entity. The process is very similar, and involves creating offering documents and finding people who would be interesting in acquiring the company.
Investment bankers take a percentage of the transaction as fees, similar to how a real estate agent gets paid. A 0.5% commission on a billion dollar deal is still $5 million in income for the bank. Because fees are so high, and investment bankers may only close one or two deals a year, most of our time is spent soliciting business. We do a lot of ‘free’ analysis, talking to CEOs and CFOs about what is going on the markets and what companies they could acquire, etc. The hope is that if you show them how attentive and thoughtful you are, they will eventually hire you when they need something.
Latest Answers