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Investment Banking

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Many corporations within our economy encounter attractive business opportunities which they would like to pursue. An electronics firm may wish to build a new factory to produce a recently invented product. A chemical company may want to expand its plant to meet increased demand. Investments of this nature require significant amounts of money, often greatly exceeding the funds the company has on hand. Therefore, in order to expand, the company must seek a source of funds outside the corporation.

A common source of money for corporations is the commercial bank loans. Commercial banks, however, prefer to lend for short periods of time, usually a few years. When a large investment, such as construction of a factory, is anticipated, a bank loan is generally not appropriate. The factory usually will not generate enough profit during the first few years of operation to repay a loan for the total construction cost. Therefore, a long-term method of financing is needed, and for this the corporation will often turn to an investment bank.

An investment bank is a financial intermediary; it functions as a liaison between those with excess funds to invest and those wishing to use the funds. The role of an investment banker is that of advisor to the corporation wishing to raise money. To perform this service, the investment banker analyzes the client's financial situation, recommends the preferred method of raising the required funds, and implements the agreed-upon course of action.



Industry Structure

Many companies that engage in investment banking are partnerships or internally held corporations. Under this form of organization, senior members of the firm are part owners of the company and therefore entitled to a share of its profits. Other investment banks are wholly owned subsidiaries of larger corporations. In these organizations, employees do not necessarily hold an ownership interest in the company.

In addition to traditional investment banks, some of the larger commercial banks and full-service brokerage houses offer investment banking services. They provide the same basic services available at the major investment banks, with the exception that commercial banks cannot perform the function of underwriting most securities.
 
Organizational Structure

Most investment banks consist of two main departments: corporate finance and public finance. This division into two departments is based upon the types of securities issued: The corporate finance department handles taxable bonds and stocks, while the public finance department handles tax-exempt bonds. In many firms, the corporate finance department is divided into industry and specialty groups. The personnel in industry groups are financial generalists responsible for servicing a particular industry sector. For example, the energy group is responsible for business relating to the oil, gas, and coal industries. They are generalists in that they are familiar with all of the various financing techniques appropriate for their clients.

The specialty groups are responsible for specific types of financial arrangement regardless of industry served. The personnel in these groups are specialists in a particular area, such as mergers and acquisitions, and work with personnel in the industry groups when their special skills are required.

The public finance department typically consists of industry groups, such as the public power group which handles the accounts of electric companies. The personnel in these groups are generalists dealing with a variety of financing techniques.

In order to carry out their tasks effectively, investment bankers must maintain a thorough familiarity with the investment needs of those with funds to invest as well as of those who require funds. These suppliers of funds include insurance companies, pension funds, investment companies, corporations, and individuals. Accordingly, investment bankers must look at securities issuances from the perspective of both buyer and seller and be able to structure marketable deals for their clients (sellers).

Although position titles in investment banking vary, the hierarchy of a typical firm may be represented as follows:
  • managing director

  • vice president

  • assistant vice president

  • associate
The managing directors are responsible for administration of the departments and groups within the organization and maintain contact with the firm's largest clients. The vice presidents and assistant vice presidents are responsible for carrying out the investment banking activities of a particular industry or specialty group. In this capacity, they assume total responsibility for providing the required services for a particular client's account or individual deal.

Most investment banks do not have formal training programs. Instead, training of entry-level associates is accomplished on the job. A new associate joining the corporate or public finance department becomes a member of an associate pool. This pool of personnel is assigned to one particular industry or specialty group, but individuals will work with a variety of groups in the department.

When a client requires financial assistance, the managing director or the vice president responsible for the deal assembles a team consisting of one or more associates and senior personnel. For example, a team may comprise a managing director, vice president, and two associates. Within certain limits, the associates are given a significant amount of flexibility and autonomy in structuring their work load. For example, an associate who prefers working on mergers and acquisitions generally will be permitted to concentrate more heavily in that area if the workload demands it and he or she has proved effective in this area. However, the client's needs always come first, and the basis for the associate pool is to permit training as generalists. In most firms the associate is expected to complete assignments in all areas of the department in order to develop a broad background and a thorough understanding of the various services the department provides.

The associate pool is an unstructured environment wherein you, as an associate, would not have one particular boss. Instead, you would work with various superiors on a variety of deals, often discussing your work with a vice president or assistant vice president before becoming involved in a deal. After joining a team, you would be committed to meeting any deadlines required to provide effective service to the client, regardless of additional responsibilities from your participation in other deals. You therefore must be capable of managing your time and work load. A typical work load can involve an average 60-70 hours per week, and include weekend work.

Performance evaluations are conducted with input from the various senior members of the firm with whom the associate has worked. An associate who is promoted to assistant vice president joins a particular industry or specialty group within the department. Which group the new assistant vice president joins depends upon the company's staffing requirements and the individual's preferences and capabilities.

The rate at which an associate progresses through the company depends upon his or her contribution, but a typical career path can be considered to be three or four years as an associate and five years as assistant vice president. The amount of time it takes to move from vice president to managing director is highly variable. Compensation in investment banks is usually salary plus bonus, the latter determined by the employee's accomplishments as well as the firm's overall profitability.

Investment Banking Services

Most investment banks offer a wide range of financial services to meet the needs of clients; the most important are discussed below.

UNDERWRITING

As mentioned previously, a corporation's issuance of equity and debt securities (stocks and bonds, respectively) provides it with a means of raising large amounts of capital. Investment banks perform the role of "underwriter" in this process by purchasing the securities (stocks or bonds) from the client and then reselling them to institutions (i.e., insurance companies, pension funds) and individual investors. The investment banking firm realizes a profit by reselling the securities at a higher price than paid for them.

Private placements provide clients with a means of raising funds by entering into a private securities transaction with an institution such as an insurance company or pension fund without having the transaction published by a major stock exchange. These transactions are usually in the form of a long-term debt agreement committing the client to repay funds to the institution at a negotiated interest rate.

MERGERS AND ACQUISITIONS

Mergers and acquisitions provide clients with a means of expanding their company through the purchase of another firm. Conversely, this service also provides clients with a means of resisting the unwanted sale of their company to another firm. The process of arranging a merger or acquisition is often a lengthy one handled primarily by senior management. The associates' role here is generally one of financial analysis-similar to that of the securities analyst.

PROJECT FINANCE

Project finance provides clients with a method of raising funds by issuing bonds for a specific venture or project. The revenues realized from the project will be used to retire (buy back) the bonds. For example, an electric utility company may use project finance to secure funds for construction of a hydroelectric plant. The revenue realized from the sale of electricity generated by this plant would be used to repay the funds. Again, as with the two following services, the associate's role is likely to be that of a financial analyst focusing on a particular firm and project.

FINANCIAL ADVISORY SERVICES

Financial advisory services provided by investment banks offer clients recommendations for planning the financial structure of their organizations. Areas of investigation may include long-term financial planning, stock re-purchase decisions, dividend policy, and working capital management.

LEASE FINANCING

Lease financing provides clients with a means of acquiring equipment or facilities without purchasing them outright. Investment bankers analyze individual situations for their clients to determine whether leasing or buying assets will prove the most profitable, taking into consideration the client's present financing and tax factors and current opportunities. Exchange of investment tax credits between corporations through a leasing agreement may be involved.

Required Skills and Educational Background

Having an MBA is almost always a prerequisite for employment as an investment banker. Major investment banks usually hire MBA graduates only from prestigious business schools. Those in the industry who do not have an MBA usually have significant and applicable work experience or a law degree.

To be an investment banker you must have strong quantitative and financial skills, as do most people in the financial service industry. You must also have mature, developed analytical skills and the ability to think creatively. Unlike someone, such as a loan officer, who works in a specialized segment of the financial service industry, an investment banker must synthesize all aspects of the industry, which requires imaginative, innovative thinking. He or she needs good oral and written communication skills, for even the best ideas must be well communicated in order to be sold.

Investment banking work is typically very demanding, and you must be willing and able to spend long hours in the office and traveling. You must be able to work well under pressure-from bosses, clients, and the clock. In addition, it is important to remember that investment banking is a highly competitive field, and the most successful investment bankers are those who combine superior intelligence and skills with strong, powerful internal motivation and desire for achievement. In summary, most successful investment bankers exhibit the following personal characteristics:
  • very strong interpersonal skills

  • superior analytical skills

  • oral and written communication skills

  • willingness to travel and work long hours

  • strong desire for success and achievement

  • internal motivation

  • high intelligence

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