Primer On Investment Banking

Primer on Investment Banking
Investment Banking:
Investment banking is an umbrella term for many services that an investment bank provides
to companies like underwriting, financial advisory services, research, funding, sales and
trading activities and managing assets of the companies. Investment Banks generally deal
with institutional clients and wealthy individuals.
Sales and Trading: The primary purpose of an investment bank is to “make market” by
buying and selling financial products. The “Sales team” of an investment bank is associated
with selling financial products and trading strategies to institutional and high net worth
private investors. Sales people communicate clients’ order to the appropriate “trading desk”,
which will then execute the order per specific requirement of the client.
Proprietary Trading is the trading activity that bank undertakes on its own account. “Prop
desk” people do not interface with clients but they trade heavily on banks own money. This
kind of trading can be done and is usually done in stocks, bonds, currencies, commodities,
derivatives etc.
Research: Two categories of research are Equity Research (Stock) and Fixed Income
Research (Bonds). Research analyst reviews the company for its financial strength and ability
to meet its obligations and promises. Each analyst covers 10-15 companies in a particular
industry segment or sub-segment. The aim of the equity research undertaken on a company is
to come up with a fair price of the company share. Depending upon the prevailing market
price, the analyst will issue “Buy”, “Hold” or “Sell” rating. Fixed income research, deals with
corporate bonds, though the considerations are almost similar as in equity, however, there is a
little difference in the approach to accommodate the differences in the characteristics of the
instruments i.e., debt vs. equity.
Bank makes money by publishing these researches and selling them for a price. Research
analysts also advise high net worth clients on investments.
An investment bank may be involved in providing both advisory services and conducting
research on a company for example, same investment bank may be lead underwriter for a
company’s next public issue and the company may also covered by bank’s research analyst.
As is suspected there is possible situation for conflict of interest. In absence of regulations,
research will issue high recommendations for the issue that is underwritten by the bank. To
avoid such situation there are strict regulations and a “Chinese Wall” is put up between
research and advisory services desks of the bank i.e. there is no communication in any way
between these two businesses. Investment banks follow these regulations religiously without
any fail.
On the basis of what kind of employer employs the analysts, research could be “Buy-
side” or “Sell-side”.
Buy-side analysts are usually employed by mutual funds, hedge funds, pension funds, etc.
The objective with which buy-side analysts undertake research is to determine how promising
investment in a particular company will be and how it fits the investment strategy and goals
of the money manager. The analysts hired are paid for by the fund and these researches are
not generally available for use by other parties.
“Sell-side” analysts work for brokerage firms, involved in managing individual accounts and
issue recommendations regarding the performance of the stock or bond they are covering.
The purpose of the research is to help their clients make knowledgeable decision to buy or
sell a security.
Financial Advisory Services:
An investment bank is involved heavily in financial advisory services. Investment banks give
companies advice on mergers and acquisition, when and how capital should be raised,
tracking the market for the best possible time to offer an IPO or secondary offering etc.
Apart from advisory services, investment bank operates extensively in Capital Markets arena.
The term capital markets, relates to equity and bond markets, both domestic and international,
as well as cover derivatives and other financial instruments. Over years with development of
securitization and derivatives market a whole new segment of Structured Transaction has
surfaced in investment banking business.
To work in research and financial advisory services area of Investment Banks, one requires
expertise in excel based financial modeling and valuation. Though, a job in capital market
groups will require in-depth knowledge of functioning of capital markets, analytics of various
financial instruments like convertible securities, derivatives etc and excel based modeling
skills.
There are certain other banking related activities that might be undertaken by an investment
bank itself or by firms specializing in these areas, for example Private Equity, Venture
Capital etc.
Private Equity:
Private equity implies equity investment in companies that are not traded publically. Private
equity investment may be in the form of Leveraged Buy-Outs, Venture Capital or Distressed
Financing.
Private Equity capital is very risky investment with huge payout potential. However, each
kind of private equity investment has different risk return profile.
In case of leveraged buyouts, private equity fund buys a large portion of a publically traded
company and takes it private, turns it around by taking over management and a complete
operational overhaul. The investment horizon is generally 5-9 years, at the end of which
company is taken public again and the private equity fund gets it investment back along with
huge returns.

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