How does investment bank make money

An investment bank, including Bank of America, JPMorgan Chase and Goldman Sachs, provides institutional clients with large-scale transactions and investment financing or convenience. But this is an oversimplified view of how investment banks make money. In fact, there are several aspects to what they do.

Key points

  • Investment banks provide a variety of financial services, including research, trading, underwriting and M&A transaction consulting.
  • Proprietary trading is an effort to make profits through trading company’s own capital.
  • Investment banks earn commissions and fees by underwriting newly issued securities through bond issuance or stock IPO.
  • Investment banks also often act as asset managers for their clients.

Brokerage and underwriting services

Like traditional intermediaries, large investment banks connect buyers and sellers in different markets. For this service, they charge trading commissions. Trading ranges from simple stock transactions for small investors to large-scale transactions for large financial institutions.

When the company needs to raise funds, investment banks will also provide underwriting services. For example, a bank may buy shares in an initial public offering (IPO) and then sell the shares to investors. There is a risk that banks cannot sell stocks at higher prices, so investment banks may lose money in the IPO. In response to this risk, some investment banks charge a fixed fee for the underwriting process.

M&A

Investment banks charge fees to act as consultants for spin-offs and mergers and acquisitions (M&A). In the spin-off, the target company sells part of its business to improve efficiency or inject cash flow. On the other hand, as long as one company acquires another company, an acquisition will occur. A merger occurs when two companies merge to form a single entity. These are usually complex transactions that require a lot of legal and financial help, especially for companies that are not familiar with the process.

Create a mortgage product

Investment banks may accept large amounts of small loans, such as mortgage loans, and then package them into a type of security. This concept is somewhat similar to a bond mutual fund, except that the collateral instrument is a collection of smaller debts, rather than corporate and government bonds. Investment banks must buy loans to package and sell them, so they try to make a profit by buying them at low prices and selling them at high prices in the market.

Proprietary trading

Through proprietary trading, investment banks put their own funds into the financial market. Traders who risk company capital are usually paid based on performance, successful traders get huge bonuses, and unsuccessful traders lose their jobs. Since the implementation of new regulations after the 2007-2008 financial crisis, proprietary trading has become less common.

Dark pool

Suppose an institutional investor wants to sell millions of shares, the scale of which is large enough to affect the market immediately. Other investors in the market may see large orders, which provide aggressive traders with high-speed technology an opportunity to sell first in an attempt to profit from the upcoming move. Investment banks set up dark pools to attract institutional sellers into secret and anonymous markets to prevent preemptive transactions. The bank charges a service fee.

Swap

Investment bankers sometimes make money through swaps. Swaps create profit opportunities through a complex form of arbitrage, in which investment banks facilitate transactions between two parties that trade their respective cash flows. The most common swaps occur when both parties realize that they may benefit from a change in the benchmark, such as interest rates or exchange rates.

Market maker

Investment banks usually have a market-making business, which aims to generate income by providing liquidity in stocks or other markets. The market maker displays the quotation (buying price and selling price) and earns a small difference between the two prices, also known as the bid-ask spread.

Investment research

Major investment banks can also sell direct research to financial experts. Fund managers often buy research reports from large institutions such as JPMorgan Chase and Goldman Sachs to make better investment decisions.

asset Management

In other cases, investment banks directly act as asset managers for major clients. Banks may have internal fund departments, including internal hedge funds, which often have attractive fee structures. Asset management can be very profitable because the client’s investment portfolio is large.

Finally, investment banks sometimes cooperate with venture capital or private equity funds or create venture capital or private equity funds to raise funds and invest in private assets. The idea is to buy a promising target company, usually with great influence, and then resell or go public after the company becomes more valuable.

Bottom line

In a capitalist economy, investment bankers play a role in helping clients raise funds to fund various activities and develop businesses. They are financial advisory intermediaries, helping to price capital and allocate it to various uses.

Although this activity helped to stabilize the wheels of capitalism, the role of investment bankers was under scrutiny because of criticism that their remuneration was too high compared to the services they provided.

.

READ ALSO:   How can a business transaction take place in an EDI?
Share your love