What Is an Investment Bank?

What Is an Investment Bank?

Investment banks originated in the USA. Most of them developed their underwriting, distribution and trading expertise from acting as brokers.

In the USA in the 1850's a lot of capital was needed as companies rapidly expanded across the country. At the same time, the size of the country stifled communication, needed for this rapid expansion. Consequently stock exchanges and brokers started up in many major cities to better reach and serve investors.

This provided them with the ability to underwrite and distribute, by having close contact with a wide spread of investors. However, these investors would only buy securities if they knew they could sell them in the future so brokers were forced to provide buy-back facilities.

Gradually investment banks developed from these brokers. There are exceptions, such as Goldman Sachs, a firm which used its knowledge of markets and skill at corporate finance (in particular Mergers & Acquisitions to create its name.

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What Do Investment Banks Do?

The work of investment banks can be separated into two categories:

• Primary market activity
• Secondary market activity

Note: One thing investment banks do NOT do is invest.

Primary Market Activity

Investment banks help companies that want to raise money. Their key role (primary market activity) is distribution and underwriting the issue of securities by companies.

All this activity is designed to get brand new securities issued and can also be called origination.

Secondary Market Activity

Investment banks also trade securities already in issue. This encompasses:

• Market making
• Propriety trading
• Trading

Market Making

An investment bank may promise an issuer that, in return for getting the mandate to underwrite and distribute its bonds, the bank will be prepared to buy and sell them (make a market in them).

This means that anyone who buys the bonds knows they can sell them again, which encourages their purchase.

Propriety Trading

This is where an Investment bank buys and sells bonds for its own account, putting its own capital at risk to do so.

Trading

This is the generic term for secondary market activity and covers propriety trading, market making and dealing in bonds on behalf of others (acting as a broker or intermediary).