Investment Bank Business Model-How Does It Make Money?

An Investment Bank is a financial company or a corporate division that acts as intermediaries between institutions, corporate bodies, and governments.

Their main aim and objective are to offer financial-based transaction advice to organizations about their investment needs. It is a business with great financial reward because of its many ways money is made.

The investment bank is an associate of corporate finance, and thus, helps with raising financial capital by underwriting or posing as the client’s agent for issuing the security.

An Investment bank also assists companies involved in Mergers & Acquisitions (M&A) to provide the necessary support for its organizations, such as Market trading, equity services, etc.

Investment Banking Business Models

The investment banking business sits at the forefront of the financial industry. It also has a unique business model that is different from that of any other business in the industry.

#1 The Several Divisions of Investment Banking

The banking industry comes in three divisions which are responsible for raising capital for companies. We have the front, the middle, and the back office.

The front office of investment banking is responsible for its revenues. This front office earns its commissions on the terms of underwriting share subscriptions for the companies.

The middle office is in charge of quality controls. This signifies the help they render to the front office, to prevent them from taking too many risks. While the back office handles the technical analysis and compiles the financial reports for the bank’s clients.

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#2 Buying and Selling of Shares

The investment banking business model deals with buying shares directly from companies and then reselling at a slight price difference. Companies that sell their shares to the public, get to sell all to the investment banks.

If there is not enough demand for those same shares, the investment banks get to hold the stock remaining from the company. This is how they make their money from Initial Public Offer (IPO), and new stock issues.

#3 Pitching Deals

For someone who wants to build a career in investment banking, working on your sales skills is very important as it helps you in pitching deals to prospective clients.

As an investment banker, there isn’t much technical analysis to be done but financial analysis because it is an essential part of the operations in investment banking.

It is advisable to work on your sales skills before venturing into the investment banking world. This skill will come in handy for you as you pitch deals and create good relationships with clients.

#4 Bank Marketing Responsibility

In the sales of shares to the public, which requires a lot of interest to be generated, investment banking is responsible for most of its marketing strategy. This is a substantial part of their business that ensures that a full subscription and an advertising budget are made for this same purpose.

Since technology has proven and still proving its worth in every sector, digital marketing can help with the sale of the company’s stock. Carrying out an offline and online marketing operation will ensure a massive sale of the shares.

#5 The Focus on some Particular Industries

Investment banking has the authority to underwrite the shares of any company. However, their main focus is on industries such as financial services, engineering, technology, and real estate. Their works involve corporate restructuring, mergers & acquisitions, and leveraged finance.

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How Investment Banks Make Money

Investment banks aim to provide for their clients a variety of financial services which includes research, trading, underwriting, and advising on mergers and acquisition deals.

#1. Brokerage and Underwriting Services

Buyers and sellers in different markets get connected by the large investment banks with a charge in commission on every trade.

Trades like simple stock for smaller investors and large trading blocs for big financial institutions. They also do the underwriting services if companies need a raise in the capital.

The risk associated with banks that buy stock from the initial public offering, and try to sell them to investors is the fact that they may likely not sell the shares at a high price.

This may lead to investment banking losing money on the IPO. So to prevent a scenario like this, they charge less for the underwriting procedure.

#2. Mergers & Acquisition

Mergers take place when two companies join together to form an entity. While an acquisition on the other hand occurs when one company decides to buy another company.

For those companies that are not conversant with this kind of process, thorough legal and financial help is required.

#3. Creating Collateralized Products

Investment banks gather their collateral products such as smaller mortgages, package them and sell them to make profits.

They do this with smaller institutions, as they buy them cheap and sell at higher prices in the market because of the huge gain they can make from it.

#4. Dark Pools

If an institutional investor decides to trade shares worth millions, that is large enough to impact the markets at that instant.

If a host of other investors gets wind of it, it will turn out as an opportunity for aggressive traders with high-quality technology to want to run the sale in the frontline to profit from the movement.

This is where the investment banks create a dark pool to lure institutional sellers in secret to prevent the front-running and also place a charge fee for the service.

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#5. Swaps

Swaps are created for the sole aim of profiting from opportunities through the buying and selling of commodities to take advantage of differing prices for the same asset.

Swaps can also occur when two parties realize the mutual benefit they stand to gain from interest rates and exchange rates. Investment bankers make money from these swaps.

#6. Market Making

Market-making operations are mostly designed to generate revenue from the provisions of liquidity in stocks or markets.

In a market-making operation, a market maker sends out his quote (buying & selling price) and earns from it but with a slight difference between the two prices.

#7. Investment Research

On investment research, the majority of investment banks can trade direct research to financial specialists.

These money managers buy their research from large institutions to assist them in making better investment decisions.

#8. Asset Management

Investment banks serve directly as asset managers to large clients. Their internal fund departments often come with an attractive fee structure.

This management is very lucrative because of the large client portfolios. Investment banks partner or create private equity funds to raise money and also invest in private assets.

One of their ideas is to purchase a promising target that has lots of leverage, and then resell it or make the company public after it becomes very valuable.

Conclusion

In an economy such as this, an investment banker helps his client raise capital to finance his activities and to also grow his businesses. They act as financial advisers to help with price capital and its allocation to different uses.

Though the activity of the investment bankers helps with the smoothness of capitalism, some people still believe that they are overpaid in connection to the services they render. 

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