Investment banks were essentially created in the U.S. by the passage of the GlassSteagall Act.
Prior to this, investment banking activities were part of large, money-center commercial banks.
The lines between investment banks and commercial banks again begins to blur as legal separation between investment banks and commercial banks is no longer required.
An
investment bank is split into the so-called Front Office, Middle Office and Back Office.
Investment Banking is the traditional aspect of investment banks which involves helping customers raise funds in the Capital Markets and advising on mergers and acquisitions. Investment bankers prepare idea pitches that they bring to meetings with their clients, with the expectation that their effort will be rewarded with a mandate when the client is ready to undertake a transaction.
Middle Office role is to ensure that the above mentioned economic risks are captured accurately (as per agreement of commercial terms with the counterparty) correctly (as per standardized booking models in the most appropriate systems) and on time (typically within 30 minutes of trade execution).
Operations involves data-checking trades that have been conducted, ensuring that they are not erroneous, and transacting the required transfers. While it provides the greatest job security of the divisions within an investment bank,
Investment banks play many roles in both the primary and secondary markets. We will focus on their role in three areas:
Underwriting Stocks and Bonds Equity Sales Mergers and Acquisitions
The process of underwriting a stock or a bond issue requires that the investment banker purchase the entire offering at a predetermined price and then resell the offering (securities) in the market. The services provided during this process include:
Giving Advice Filing Documents Underwriting, Best Efforts, or Private Placement
Giving advice
Explaining current market conditions in to help determine why type of security (equity, debt, etc.) to offer Assisting in determining when to issue, how many, at what price (more important with IPOs than SEOs)
Filing Documents
SEC registration (filing) is required for issues greater than $1.5 million and with a maturity greater than 270 days. A portion of the registration statement known as the prospectus is made available to the public. Debt issues require several additional steps, including acquiring a credit rating, hire a bond counsel, etc. For equity issues, the investment banker may also arrange for the securities to appear on one of the exchanges.
Underwriting (firm commitment)
The investment banker purchases the entire offering at a fixed price and then resells the offering to the market. An underwriter may form an underwriting syndicate to diffuse part of the underwriting risk. Placement of a tombstone in, for instance, the Wall Street Journal (example on next slide).
The goal of underwriting is for all of the shares in an offering to be spoken for. However, this may not occur.
Fully subscribed: all shares are spoken for Undersubscribed: underwriting syndicate unable to generate interest in all of the available shares Oversubscribed: interest in more shares than are available (may lead to rationing).
Figure 23.1 Using Investment Bankers to Distribute Securities to the Public
Best Efforts: An alternative to a firm commitment, the underwriter does not buy the issue, but rather makes its best effort to sell the entire issue.
Private Placements: The entire issue is sold to a small, select group of investors. This is rarely done with equity issues.
When a firm sells an entire division (or maybe the entire company), enlisting the aid of an investment banker.
Assists in determining the value of the division or firm and find potential buyers Develop confidential financial statements for the division for prospective buyer (confidential memorandum) Prepare a letter of intent to continue, assist with due diligence, and help reach a definitive agreement
Investment bankers may assist both acquiring firms and potential targets (although not both in the same deal).
Deal may be a hostile takeover, where the target does not wish to be acquired. Investment bankers will assist in all areas, including deal specifics, lining up financing, legal issues, etc.
