1. Investment Banking

Investment Banking

From About Wiki, for About.com

Investment banks create securities, including stocks and bonds, for themselves and other companies, and facilitate the trade in them. They also help companies manage mergers and acquisitions.

The primary role of investment banking in the economy has traditionally been to help businesses raise capital for their operations by selling investment securities to the general public.

How Investment Banking Operations Differ From Other Banks

Unlike commercial banks and savings and loans, investment banks do not seek cash deposits from customers in the form of checking and savings accounts, and they do not make traditional interest-bearing loans to individual customers.

Investment banks instead make their money primarily

  • By advising corporate clients on the creation of stocks, bonds and other securities
  • By underwriting securities
  • By facilitating mergers and acquisitions, along with any due diligence and securities exchanges that may go along with them.
  • And by brokering (or selling) securities to investors.

Investment bankers have also created a broad array of investment options to go along with traditional stocks and bonds, including securities derivatives such as call and put options, which allow investors to lock in a buy or sell price on an investment at a future date, and credit default swaps, which insure bond buyers against the risk that a bond seller will renege on the debt.

Investment banks also lend stocks to facilitate short trades, in which speculators borrow stock and sell it in hopes that its price will decline before they rebuy it and return it to the lender.

Changes in Investment Banking

In 1933, Congress passed the Glass-Steagall Act, which separated key investment banking functions from commercial banks. In the midst of the Great Depression, lawmakers feared that combined investment and commercial banking institutions would be tempted to use money in commercial banking deposits, such as checking accounts, to bail out unwise bets on the investment banking side if the two remained combined.

Glass-Steagall was effectively repealed in 1999 and, although commercial banks and investment banks were once again given the leeway to combine under one roof, pure investment banks enjoyed greater relief from government regulations. In one notable case, the federal Securities and Exchange Commission raised the debt limit for investment banks in 2004, which allowed Wall Street’s largest pure investment banks, such as Merrill Lynch, Lehman Brothers, Bear Stearns and Goldman Sachs, to invest more freely with borrowed money – an option largely denied to commercial banks, who were forced to maintain higher levels of cash and securities reserves to back up their loans and investments.

The playing field shifted again in 2008, when a widespread financial crisis forced all of the largest surviving Wall Street firms to convert themselves into bank holding companies in order to gain eligibility for federal aid.

The move transferred the firms from the investment-oriented regulatory oversight of the Securities and Exchange Commission to the commercial banking-oriented regulation of the Federal Reserve, with consequences that are still unclear.

Careers in Investment Banking

Despite setbacks in hiring and controversies over compensation packages that began with the financial disruptions of 2008, careers in investment banking still tend to be relatively highly paid, if not in as high a demand as they once were.

The salary ranges forecast for 2009 through 2011 by Careers-In-Finance.com predicted that the typical first-year analyst in an investment firm could expect to make $90,000 a year with no more than a bachelor’s degree, while a third-year associate with a Masters in Business Administration could expect to make $300,000 and a department head could expect to bring in $2 million a year.

Future of Investment Banking

While there will always be a need in a capitalist economy for the functions of traditional investment banking, the business model of investment banking going forward is murky as the first decade of the 21st Century draws to a close.

In the United States, standalone investment banks like Merrill Lynch and Goldman Sachs appear to have given way to so-called universal banks, such as Bank of America (which absorbed Merrill Lynch in late 2008), J.P. Morgan Chase and Citibank, which all attempt to marry the stability of retail and commercial banking deposits with the riskier and more high-flying world of investment banking. Meanwhile, smaller so-called boutique investment banks, some of which concentrate on geographic regions and some of which concentrate on niche investors, continue to thrive and to compete with the larger conglomerates for talent.

Related Investment Banking Resources

The Wall Street Guide: Boutique Investment Banks [1]

Securities and Exchange Commission: Definition of a Short Sale [2]

Investorwords: Credit Default Swaps [3]

About.com U.S. Economy: Stock Option Trading Defined [4]

About.com Beginners Investing: Investment Banking Basics [5]

Investopedia: Due Diligence Definition [6]

Business Finance: Types of Investment Bank Funding [7]

Careers In Finance: Investment Banking Salaries [8]

Careers in Finance: Life As An Investment Banking Analyst [9]

Careers in Finance: Life As An Investment Banking Associate [10]

Investopedia: The History of the Glass-Steagall Act [11]

About.com Finance Careers: Investment Banker Career Overview [12]

About.com Finance Careers: Securities Underwriting [13]

About.com Banking: What Is An Investment Bank? [14]

About.com Banking: Types of Banks [15]

About.com Banking: What Is a Retail Bank? [16]

About.com Banking: What Is a Commercial Bank? [17]

About.com Bonds: Underwriters and Underwriting [18]

About.com Banking: Goldman Sachs, Morgan Stanley Take To Banking [19]

Forbes: Why Goldman Sachs and Morgan Stanley Ran For The Fed [20]

About.com U.S. Economy: Why Wall Street Is Forever Changed [21]

About.com U.S. Politics: SEC Lifted Debt Limit for Investment Banks in 2004 [22]

About.com U.S. Economy: Top 10 Economic Events of 2008 [23]

Wisegeek.com: What Is Investment Banking? [24]

Wisegeek.com: What Is a Merger? [25]

Investorwords.com: Investment Bank Definition [26]

The Economist: Is There A Future For Investment Banking? [27]

Encyclopedia Britannica: Investment Banking [28]

National Investment Banking Association [29]

Investment Banking Explained: An Insider’s Guide to the Industry [30]

Financial Dictionary Investment Bank [31]

Investorwords: Dictionary of Investment Terms [32]

Private Equity Database: Glossary of Investment Terms [33]

U.S. Securities and Exchange Commission: Check Out Brokers and Investment Advisers [34]

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