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What are investment banks and what types of activities do they carry out?

A investment bank (or investment bank) is a financial company that helps individuals and organizations raise funds and provides financial advisory services. Its main objective is to act as Middleman between investors and those in need of capital.

The activities of investment banks can be divided between "sell side"(sales side) orbuy side"(side of purchase). The "sale side" involves trading securities (e.g., shares or company debts) for cash or other securities, or promoting such securities (e.g., underwriting them). The "purchase side" involves providing financial advice to institutions buying these securities, such as mutual funds.

We can divide the main financial activities of investment banks into 4 areas: Subscription, Financial Advice, Fundraising and Investment e Market Creation

Subscription

Underwriting refers to the process that investment banks undertake to guarantee payments in the event of financial losses to institutions and companies involved in some financial transaction, incurring the risk of making such a guarantee. For this purpose, an investment bank assesses the eligibility of a client to receive its products (such as equity, insurance, mortgage or credit). 

In investment banks, underwriting is best known for its role in initial public offerings (IPOs). IPOs are when companies decide to sell shares in the market for the first time. To do this, each company needs to set a price for its shares; companies want to set a price high enough to raise as much money as possible, but low enough to sell the number of shares they want. 

Thus, there is a risk for companies in offering securities. For all types of securities, whether offered by companies or the government, there is a risk that the issuer will not be able to have a successful offer.

This is where the work of underwriting securities comes in. Investment banks that underwrite an offer offer offer to assume part of the risk in exchange for a premium. In essence, the bank buys the issuer's securities and then goes on to sell the securities on the market. This means that the issuing company receives the money in advance. 

The issuing company knows that it is probably not getting the full market value of the bonds, but it is okay because it no longer has the risk of having to find enough buyers to buy the bonds at a desirable price. The investment bank does this because if it can sell the bonds in the market at a price higher than the purchase price, it can make a profit.

Financial Advisory: Mergers and Acquisitions (M&A)

Investment banks also provide advice to clients seeking to expand their business to become more profitable through the process known as mergers e purchases.

In a mergerA company joins with another to share customers and assets, creating a totally new entity. In a purchaseA company buys a smaller organization and absorbs its assets.

For example, if a company wants to sell a non-profit division, it will hire an investment bank to find a company that wants to buy it. Investment banks play a big role in facilitation of mergers and acquisitions operations. The advisory group is in charge of helping buyers find sellers and vice-versa, and then facilitating the business.

Due to the complex nature of combining two companies, investment bankers on both sides of the business work in large teams to ensure everything goes smoothly. Information on mergers and acquisitions should be kept at secrecy until public disclosure, because news of a business may impact what an investor thinks about the ownership of securities (shares and/or bonds) in the business.

Fundraising and Investment

Suppose a company does not want to be acquired and cannot (or wants to) obtain loans from banks at the desired level. However, this firm still needs to raise capital but cannot access public markets, such as the stock market; thus, one option is to hire an investment bank, which would act as an intermediary funding agent between the firm and the investors. This allows the company not only to connect with investors, but also to better focus on managing its activities.

Types of capital financing intermediated by investment banks for private companies can come from a variety of sources. Three of the main sources of capital are:

Equity financing. Private companies may sell part or all of their capital to investors. This is similar to selling part of the company's ownership. It may seem undesirable to sell a portion of the firm's ownership, but many firms (especially startups and fast-growing companies) need to do so to raise immediate capital in order to finance future growth.

Capital Mezzanine. Corresponds to a type of debt used to finance long-term investment projects, which combines, in the same transaction, capital (shares and other forms of equity participation) and debt. The objective of this type of financing is generally to finance growth strategies through a hybrid financing instrument, which may be more convenient for the company's objectives.

Special financing. This may include financing such as government loans or special grants to which the company qualifies. Investment banks are usually compensated through fee agreements based on the amount of money raised by the fund or the company they represent.

Market Creation

On the major stock exchanges there are enough people who want to buy or sell at any time, so it is usually easy to find someone to trade with if you are making an offer/purchase of some securities. This facility is called liquidity.  

However, there are cases when there is no liquidity. Lack of liquidity is very bad for investors. If they feel they can't buy/sell the shares when they need them, they will choose not to trade those shares.  

It is in this context that another type of area of action of investment banks enters, that of "market creation". The role of market maker is to quote both a selling price and a buying price for a security. This helps to provide liquidity to the market, making it more efficient. For this reason, many exchanges designate investment banks to function as market makers for certain securities. 

The financial reason why market makers do this is because the selling price they present will always be a little higher than what is offered. This is the so-called bid-ask spread which provides the revenue opportunity for investment banks. A bid-ask spread of even a penny can mean a huge profit when trading many stocks.

Thus, regardless of the product or category of coverage, the interest of an investment bank is to guarantee agility e efficiency the financial demands of customers. It is to be an intermediary in the main financial operations of companies and institutions and to embrace the intersection of technical knowledge and human relations.

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