Investment Banking in Plain English

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Investment Banking city of London

From time to time we’re  asked the questions What is Investment Banking and how does it differ from a commercial bank?

Unless you work in finance, the term investment banking likely did not present itself in your day-to-day life until the 2008-2009 global meltdown began.

So let’s break it down.

What Is an Investment Bank?

To put it simply, an investment bank is nothing like the corner institution you’re used to dealing with to get a business loan or deposit your account. Instead, an investment bank is a particular type of financial institution that works primarily in high finance by helping companies access the capital markets (stock market and bond market) to raise money for expansion or other needs.

Sometimes, investment banks come up with novel solutions to solve difficult problems.

Years ago, Berkshire Hathaway had only a single class of stock.  Because its controlling shareholder, billionaire Warren Buffett, had refused to split the capital, the shares had grown from $8 to $35,400; far out of the reach of the typical investor.

Money managers were creating mutual fund-like structures to buy these shares and then issuing shares in themselves, taking a fee, to make the firm accessible to ordinary families.  Buffett didn’t like these middlemen making wild promises about the potential returns he could generate when he had nothing to do with it, so to take away their business, he worked with his investment firm to create a dual-class capital structure.

Therefore, on May of 1996, Berkshire Hathaway had an IPO for the Class B shares, which traded at 1/30th the value of the Class A shares (the old stock) but had only 1/200th the voting rights and the rest is history.

The Two Sides of Investment Banking

Investment banks are divided into two segments: the buy side and the sell side. The sell-side typically refers to selling shares of newly issued IPOs, placing new bond issues, engaging in market making services, or helping clients facilitate transactions.

The buy side, in contrast, works with pension funds, collective investment schemes and the investing public to help them maximise their returns when trading or investing in securities such as stocks and bonds.

Typical Investment Bank Activities

A typical investment bank will engage in some or all of the following activities:

Raise equity capital (e.g., helping launch an IPO or creating a special class of preferred stock.)

Raise debt capital (e.g., issuing bonds to help raise money for a factory expansion)

Launching new products (e.g., such as credit default swaps).

Engage in proprietary trading where teams of in-house money managers invest or trade the company’s own money for its private account.

Is investment banking an option you would consider for your business?

Let us know.

If you liked this article and want to read other great stories, try our Archives. Also if you are new to investing you can try our Investment Basics Blog.

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