Believe it or not, even investment bankers find it difficult to describe what exactly investment banks do! This has to do with the sheer complexity and enormity of the financial transactions involved.
In simple words, an investment bank is an intermediary between organizations such as ABC Steel that need money and individuals and institutions that need to invest. Broadly speaking, an investment bank is an institution that:
Helps organizations or government to raise money by issuing and selling securities such as stocks and bonds.
Provides a range of advisory services on complex transactions such as mergers and acquisitions.
Offers a range of structured products and services to institutional and individual investors to help them manage their assets and wealth.
[/list]
Role of an Investment Bank
Investment banks could play different roles in a financial transaction. Some of the most common roles played by them are:
Underwriter
Principal Trader
Broker or Agent
Prime Broker
Advisor
[/list]
Underwriter
Principal Trader
As a principal trader, an investment bank buys shares from other investment banks and investors and keeps them in its inventory. It may sell these shares at a higher price in the future. The term ‘principal trading’ simply means that the trader of securities is also its owner or principal.
For example, after ABC Steel’s shares are sold to the public, an investment bank may purchase some of these shares from the market. It may sell these shares later when the price rises.
Broker or Agent
The important thing to remember here is that the brokerage or agency represents buyers or sellers who are the principals or owners of the securities.
Prime Broker
Administrative and operational support for trading
Lending of securities
Management and safeguarding of securities
Financing
[/list]
Without a prime broker, it would be difficult for professional investors to trade with several different brokers and manage their cash and securities from one centralized account.
Advisor
Why an Investment Bank
Investment banks have a large pool of experts who are well versed with market regulations and conditions. Moreover, they are more cost effective due to their scale of operation and optimal use of technology. Considering all this, it would be too expensive and time consuming to not use an investment bank.
Investment Banking Structure
Let’s now take a look at what a typical investment bank is structured like. Usually, all investment banks consist of three units—front office, middle office and back office.
Front Office
The front office refers to the sales, marketing, trading and other divisions that involve customer interaction and revenue generation. The front office of an investment bank typically handles the following functions:
Investment management
Investment banking
Research
Strategy
Trading and sales
Structuring of complex financial instruments such as derivatives
[/list]
Middle Office
The middle office of an investment bank manages risk. For an investment bank, risk can be of two types:
Market risk – the risk of decrease in value of investments due to market fluctuations
Credit risk – the risk of loss due to non-payment of a loan
[/list]
The middle office calculates profits and losses. It also analyzes the risk of trading portfolios and ensures compliance with regulations. It works closely with both the front and back office.
Back Office
The back office consists of the operational and administrative functions of the investment bank. Typically, the back office handles the following functions:
Clearing
Settlement
Regulatory compliance
Record-keeping
Reporting of transactions
[/list]
The back office may also consist of a technology division that creates software tools that automate processes and integrate different systems.
Career Options in Investment Banking
India was more of a cost arbitrage destination but is the talent in India makes it a value addition destination. More and more knowledge intensive processes are finding ways to India. These involve processes like valuation validation, Investment research and product control. Such processes require a high degree of specialization and competencies thereby providing excellent career opportunities for Finance graduates. Chartered Accountants, CFAs and MBAs have a strong foundation of Finance and with an incremental specialized training in these areas, are perfectly poised to take on some of critical roles in an Investment Bank. Some indicative avenues are:
Financial planning and Analysis:
Overseeing the accounting / financial / regulatory reporting for the firm.
Prepare external financial Reports for public filings, tax And regulators.
Monitor limits and maximize efficiency of financial and capital resources
Management reporting & analytics to the business management teams
[/list]
Product Control
Team provides PnL substantiation coverage across securities, derivatives & capital market groups & Investment Management.
Perform price Testing and off market rate checking and resolve variance
Assist with P&L report, production of Trading, Accrual and Funding books.
Ensure accuracy in terms of classifications, entities, Value and booking of transactions
[/list]
Corporate Treasury and Tax
Provides corporate finance advisory services to management & business units, maintaining the firm’s liquidity, optimizing its capital base.
Cash management, tax arbitrage & calculations The tax ensures compliance with income and indirect tax filings.
[/list]
Fund Administration
Fund Administration is name given to the set of activities that are carried out in support of the actual process of running a collective investment scheme, whether the scheme is a traditional mutual fund, a hedge fund or something in between.
Fund Managers often choose to outsource some or all of these activities to external specialist companies; these companies are often known as fund administrators.
These administrative activities would include:
Reviews fund formation documents
Reviews registration and filing documents
Performs corporate secretarial and director services
Maintains the financial records of the fund
Maintains the general ledger and prepares a trial balance (a summary of the general ledger broken down by capital, income statement and balance sheet)
Responsible for calculation of net asset value
Responsible for the allocation of profit and loss to investors
Coordinates the annual audit
Prepares initial draft of audit package for auditors
Oversees the day-to-day operations of the fund
[/list]
Investment Research
Fund Accounting
Fund Accounting is the part of fund administration which includes processing the end to end accounting, which includes the transaction booking, reconciliation, valuation & pricing and the financial reporting to the client.
Few of the activities performed in fund accounting are:
Maintaining the fund accounting records, reconciliations with Broker/ Custodian etc.
Preparation of Balance sheet and statement of operations.
Computes the NAV, obtains security quotes, calculate Market value and Cost of investments and calculates fund appreciation/ depreciation.
Researching and Posting the Corporate Action events and ensures the accuracy of NAV.
Provides Tax lot detail, obtain shareholder activity from the transfer Agent.
It also provides the Performance analysis
[/list]
Investment Research
Investment Research is about analyzing companies and their business. Investment research helps clients invest their capital to achieve the best risk-adjusted investment returns possible. Comprehensive research analysis of the world's economies, companies and industries, enable to take informed investment decisions. Investment research also includes comprehensive quantitative analysis at both Industry and company level.
Investment Research is broadly classified into following groups:
Equity Research analysts analyze macro, sector and company fundamentals to identify investment opportunities in global stocks.
Credit Research analysts make investment recommendations for the corporate debt and credit derivatives of issuers in various industry sectors.
Economics Research analysts formulate macroeconomic forecasts for economic activity, foreign exchange rates and interest rates.
Portfolio and Strategy Research analysts formulate equity market views, forecasts and recommendations on both asset and industry sector allocations for every major market..
Commodities Research analysts analyze macro fundamentals to formulate forecasts for commodities in six main areas: Oil, Gas, Base Metals, Precious Metals, and Agriculture.
[/list]
High-end investment research services support the equities, fixed income and corporate finance divisions of banks and buy-side firms. Investment research firms hire investment analyst who are qualified MBA’s, CFA's or Chartered Accountants.
Investment banks offer a lucrative career option for CA students by providing attractive pay packages and benefits. It offers a platform for young professionals to progress in the banking industry. Hence, more and more students are looking at investment banking as a long term career prospect.