Introduction and Industry Structure

 Investment banking is concerned with the allocation of financial resources thus it is

concerned with how and why money is moved from those who have it (investors) to
those who need it (issuers). In traditional sense, the role of Investment banking is
intermediation in case of resource allocation.
 Investment Banking has been narrowly defined as those financial services
associated with the issuance, flotation of new (principally corporate) securities.
 Such Securities are issued for the purpose of providing financing fir the issuing
institution.
 Thus, Investment Banking is the act of making primary market for the securities.
 Primary market is they market where securities are first issued.
 Investment banking is also understood to include secondary market making by
brokers and dealers in securities- particularly if the secondary market making is
done in direct support of primary market making.
 Secondary market is the market in which previously issued securities are traded by
investors.
 Nowadays for many investment banks, primary and secondary market making no
longer constitute their principal revenue-generating sources. Then, What us
Investment banking? Most Inclusive answer is, Investment banking is what
investment banks do.
Figure: Investment Banking Activities
 The investment banking industry is perhaps best described as an oligopoly i.e.
relatively few firms dominate the industry.
 The largest firms are often called bulge bracket (this term is derived from the
tendency that firms’ names to be printed larger and bolder on public offering
announcements (also called tombstone) and on the front page of the prospectus.
 The bulge bracket is also known as special bracket.
 After the bulge bracket firms is the second tier of middle-sized firms, known as the
major bracket followed by third tier of small firms, called sub majors or regionals.
 Although the market is oligopolistic in nature, there exist fierce competition among
the layers.
 Investment bank range from full-service shop to boutiques.
 Full-service shops provide the full range of investment banking services
 Boutiques are called specialty shops who maintain relationships with the larger
firms.
 Financial Engineering can be defined as the development and creative application
of financial technology to solve financial problems, exploit financial opportunities
and to otherwise add value.
 Using mathematic modeling and computer engineering, financial engineers are able
to test and issue new tools such as new methods of investment analysis, new debt
offerings, new investments, new trading strategies, new financial models, etc.
 While financial engineering uses stochastics, simulations and analytics to design
and implement new financial processes to solve problems in finance, the field also
creates new strategies that companies can take advantage of to maximize
corporate profits.
 The success of an investment bank depends very much on its perceived prestige
within the community. This prestige is measured by the firm’s ranking in the
industry. Below is the list of top 10 investment bankers in the world in 2015 as
provided by Equity-Research.com:
 Investment banks can be ranked under this three major areas:

• Here, investment banks are ranked according to

Corporate aggregate underwriting (sum of debt and equity
Underwriting underwriting), total debt, equity, mortgage backed
securities, asset backed securities, proffered stock or
bonds they underwrite in a particular year.

International • These firms are ranked based on international bonds,

Eurobonds, international loans and equity facilities they
Underwriting provide in a particular year.

• Municipal underwriters are ranked based on total

Municipal underwriting, long-term negotiated issues, long term
Underwriting competitive issues, municipal issues they underwrite in a
year.
  Major revenue accounts/revenue generating activities which an investment
banker involves are:

Commissions • Brokerage accounts, mutual fund sales etc.

Interest and Dividends • Margin lending, effects of interest rate spread, net carrying costs and accrued
interest from trading positions

Principal Transaction • Trading activity (equity, fixed income, foreign exchange etc.), hedging strategies,
revenues from mortgage backed securities, swaps and derivative securities

Investment Banking • Underwriting, private placement, management fees for mergers and acquisitions,
restructuring, refinancing, advisory services etc.

Other Revenues • Merchant banking activities, consulting activities, arbitrage activities

 Below is the income statement of a leading investment banker that shows
revenue and expenditure components of an investment bank:
 The organizational structure of investment banks differs widely across firms within
the industry. It can be:
The Partnership

It can be owned by two or more partners who share

the profit of the firm

Conglomerate Unit
It’s very unusual for a large to go into bankruptcy but
in case of acquisition or merger, conglomerate unit is
formed

Public Firm
By selling ownership of the firm to the public in the
form of common stock an investment banking
company can also be formed.