Investment Banks Make Money. Nothing But Money.Investment banks provide a variety of money-making services to companies, governments and themselves. These activities include: • Venture Capital : Many banks have venture capital divisions. These groups offer capital and guidance to new companies that are experiencing strong growth. Due to their small size, they may not have access to the public equity markets. Venture capital divisions will help manage these companies get sold to larger ones or take them public. VC investments are recouped after the company goes public or is sold to another firm. The banks fees work out to be about 10% of the money raised. • Trading : A major source of income is derived from trading. Investment banks will trade securities on a client’s behalf or for its own account. The later is known as proprietary trading. Proprietary trading is a huge source of income.
Proprietary traders trade financial products using the firm’s capital. The profits go to the investment bank only. The huge bonuses go to the trader. Propriety trading does offer a few controversial aspects. One situation occurs when traders learn their clients are buying heavy into a certain stock. These traders take advantage by taking a position and profiting from the price increase. If a propriety trader owns stocks that are tanking, he may instruct the banks sales people to call some clients and try to dump the securities in their lap. Financial institutions are usually in the center of M&A. A property trader can get access to that information and trade on that knowledge. Of course banks have “Chinese walls”, so the possibilities of that happening are nil. I think.
Other money making activities include: • Arbitrage : Buy a security in a market where the price is cheap. Then sell the same security simultaneously in a market where it is more expensive. • Asset Securitization : Groups of assets are combined into pools that investors can buy. These assets include mortgages, account receivables, credit card debt, royalties and more. The investor receives the income generated from these pools of assets. I must admit. The assets can get pretty interesting. All this is done through the miracles of financial engineering. Welcome to the field of structured finance.
• M&A : Bring separate companies together so that 1+1= 3. Wall Street hopes merging two firms together will create larger shareholder value than the sum of these firms on their own. In most cases it’s a larger firm actually acquiring a smaller firm and coining it a merger. Something to do with ego I guess. Acquisitions can be a pleasant takeover of another company. Or, they can be hostile and make great a book. Investment banks earn about 1% of the M&A deal value. These deals are huge so 1% winds up being a whole lot of money. To become the one-stop-financial-shop that clients prefer, banks offer many other services. In addition to money management, divestiture and bond underwriting, investment banks offer operations and support services to smaller money management firms. There are three broad areas your job can fall in at an investment bank. Front office, middle office and back office.
The money makers sit in the front. The risk managers, p/l analysts and financial types sit the middle. Operations and support ride the back. To continue going, these institutions must have a strong international presence. The U.S. market is now considered mature. Europe, Asia and certain emerging markets are the hotbeds of opportunity. In 1869 schoolteacher Marcus Goldman and his wife Bertha started a business in which they purchased IOU’s from merchants at a discount. When the note was due, Marucs Goldman collected the full amount from whoever owed the money. The business grew substantially and son-in-law Sam Sachs joined the firm in 1882. By 1928 the Goldman Sachs Trading Corporation investment trust was formed. The trust pooled investor’s money together to buy stocks. Before October 1929 GTSC shares traded over $300-. Then the crash hit. Goldman Sachs was hit hard. GTSC shares dropped to under $2. Some of the shares contained embedded options which forced the firm to buy more shares as the prices fell. Needless to say, Goldman’s reputation was damaged for years. The loss came to $300 million. Looking back, that doesn’t seem much. Nowadays a trader can lose that in a few hours. Stanley Weinberg became Goldman Sach’s chairman from 1930 to 1969. He got his start working as a janitor. What more can I say that you don't already know. This my friends, concludes a brief intro into investment banking. If you like long hours, big money, big egos and a summer house in the Hamptons; get your resume together.
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