Investment Bank

Definition

An investment bank is a financial institution that primarily assists corporations, governments, and other entities in raising capital by underwriting and/or acting as the client’s agent in the issuance of securities. Unlike commercial banks, which primarily deal with individual deposits and loans, investment banks do not take deposits. Instead, they play a critical role in capital markets by buying shares in companies and selling them to investors in smaller lots. They also provide advice on mergers and acquisitions (M&A), restructurings, and other financial matters.

Examples

Goldman Sachs: One of the oldest and most prestigious investment banks, Goldman Sachs provides services in investment banking, securities, investment management, and consumer banking.
Morgan Stanley: Another leading global financial services firm, specializing in wealth management, investment banking, and institutional securities.
Deutsche Bank: This German multinational investment bank offers a wide range of financial services including investment banking, asset management, and commercial banking.

Frequently Asked Questions

What services do investment banks provide? Investment banks offer a variety of services including underwriting, acting as an intermediary between an issuer of securities and the investing public, assisting in mergers and acquisitions, market making, trading of derivatives, and providing advisory services for high-net-worth individuals and institutions.

How do investment banks make money? Investment banks make money through fees and commissions charged for their advisory services, underwriting fees, trading commissions, and income from their own trading activities.

What is the difference between investment banking and commercial banking? Investment banking focuses on raising capital through the issuance of securities and providing advisory services for mergers and acquisitions, whereas commercial banking focuses on deposit-taking and loan-providing services mainly to retail customers and small businesses.

How did the financial crisis of 2008 impact investment banks? The financial crisis of 2008 led to the collapse of several major investment banks, including Lehman Brothers and Bear Sterns. It resulted in significant regulatory changes aimed at improving the stability and transparency of financial markets.

Merchant Bank: Typically refers to firms that engage in underwriting and business loans, and it is more common terminology in the UK. The functions can closely align with those of investment banks in the US.

Underwriting: The process by which investment banks raise investment capital from investors on behalf of corporations and governments issuing securities.

Mergers and Acquisitions (M&A): Advisory services that investment banks provide to assist in consolidations or transfers of ownership in the corporate sector.

Capital Markets: A market for buying and selling equity and debt instruments, which investment banks facilitate through various financial activities.

Online Resources

Suggested Books for Further Studies

“Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions” by Joshua Rosenbaum and Joshua Pearl
A comprehensive guide covering valuation techniques, leveraged buyouts, and the M&A process.
“The Partnership: The Making of Goldman Sachs” by Charles D. Ellis
An intriguing look into the history and inner workings of one of the most influential investment banks.
“Barbarians at the Gate: The Fall of RJR Nabisco” by Bryan Burrough and John Helyar
A real-life account of one of the most famous leveraged buyouts in history, showcasing the role of investment banking.

Accounting Basics: “Investment Bank” Fundamentals Quiz

### What primary role do investment banks play in the financial market? - [x] Advising on mergers and acquisitions and underwriting securities. - [ ] Providing deposit and loan services to individuals. - [ ] Creating internal compliance regulations. - [ ] Issuing central bank policies. > **Explanation:** Investment banks focus on advising on mergers and acquisitions, underwriting new securities, and making markets in financial instruments. ### How do investment banks primarily generate revenue? - [x] Through fees from advisory services, underwriting, and trading commissions. - [ ] By collecting interest on savings accounts. - [ ] From government grants. - [ ] Through subscription services. > **Explanation:** Investment banks earn revenue from fees associated with advisory services, underwriting fees, and trading commissions as well as gains from proprietary trading. ### What significant event took down several leading investment banks in 2008? - [ ] Stock market boom. - [ ] A new regulatory framework. - [ ] Advancements in technology. - [x] The financial crisis of 2008. > **Explanation:** The financial crisis of 2008 led to the collapse of several major investment banks, showing the vulnerabilities in the financial system. ### Which is not typically a service provided by investment banks? - [ ] Underwriting securities. - [ ] Mergers and acquisitions advisory. - [ ] Proprietary trading. - [x] Personal savings accounts. > **Explanation:** Investment banks do not typically offer personal savings accounts as their focus is on capital market activities and advisory services. ### What distinguishes an investment bank from a commercial bank? - [ ] Investment banks issue mortgages. - [ ] Investment banks focus on lending to small businesses. - [x] Investment banks focus on capital creation and securities. - [ ] Investment banks provide retail banking services. > **Explanation:** Investment banks are distinguished by their role in raising capital, underwriting new securities, and advising on mergers and acquisitions. ### Which of the following is a major task of investment banks? - [x] Underwriting new securities. - [ ] Issuing driver's licenses. - [ ] Providing consumer checking accounts. - [ ] Enforcing tax policies. > **Explanation:** Underwriting new securities is a major function of investment banks, involving the issuing of equity and debt instruments. ### What did the Glass-Steagall Act (until its repeal) primarily restrict? - [ ] Investment banks from issuing stock. - [x] Commercial banks from engaging in securities activities. - [ ] Investment banks from advising M&A. - [ ] All banking operations across state lines. > **Explanation:** The Glass-Steagall Act restricted commercial banks from engaging in securities activities, a separation that was eased starting in the late 1980s, and largely repealed by 1999. ### What regulatory changes occurred after the 2008 financial crisis? - [ ] Stricter rules for consumer banking services. - [ ] Reduced capital requirements for banks. - [x] Imposed new regulations to improve financial stability and transparency. - [ ] Deregulation of the entire banking industry. > **Explanation:** Post the 2008 financial crisis, regulations were introduced to enhance financial stability and transparency within the system to avoid future collapses. ### Which investment bank did not survive the 2008 financial crisis? - [ ] Goldman Sachs - [x] Lehman Brothers - [ ] Morgan Stanley - [ ] J.P. Morgan > **Explanation:** Lehman Brothers was one of several major investment banks that did not survive the 2008 financial crisis. ### Why are investment banks critical in the M&A process? - [ ] They provide the needed retail banking services. - [x] They offer valuable advisory services and facilitate transactions. - [ ] They enforce the laws involved in M&A. - [ ] They issue the necessary business licenses. > **Explanation:** Investment banks are crucial as they provide advisory services and help in structuring and facilitating transactions during mergers and acquisitions.

Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!