Investment bank – what is this?

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Investment banks assist corporations in raising funds in the public markets (both equity and debt). They may also advise private individuals who have sufficient wealth (known as Private Equity or Private Banking). They are often confused with brokerages, which are firms which assist people in choosing and buying stocks, bonds, and mutual funds. (Of course, it is possible for a brokerage and an investment bank to share common ownership, and most of the largest brokerage companies also do investment banking.)

Investment banks can invest money on stock markets or use advanced products called derivatives. Investment banks can also invest money directly into companies, projects, etc., either as direct investments for which they carry the full risk, or as loans with collaterals to reduce risks. Combinations of derivatives and loans also exist, such as mezzanines.

Investment banks will typically be concerned with several business units, including Corporate Finance (concerned with managing the finances of corporations, including mergers, acquisitions and disposals), Equities (concerned with research and valuation of company shares), and Trading (concerned with buying and selling shares both on behalf of the bank’s clients and sometimes also for the bank itself). Venture capital for new or early stage ventures is also often a division of its own, although for long this was restricted in the US. Management of the bank’s own capital is often one of the biggest sources of profit; for example the banks may arbitrage in huge scale if they see a suitable opportunity and/or they may structure their books so that they profit from a fall of bond yields (a rise of bond prices).

Because potential conflicts of interest may arise between different parts of a bank, the authorities that regulate investment banking (the FSA in the United Kingdom and the SEC in the United States) require that banks impose a Chinese wall which prohibits communication between equities research and equities sales. The industry in the US has been heavily criticized, and often fined, for failing to actually restrict this communication, and for research divisions pushing stocks which are known to be very poor investments, in exchange for that company doing investment banking business with the bank.

Abuses happen also more frequently in this industry possibly due to the structure of the industry, in which the majority of the money is made by the personal investment banker handling the transaction.