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Chapter – 2
Investment Banking

 Meaning
Definition: Investment banking is a special segment of banking operation that helps
individuals or organisations raise capital and provide financial consultancy services to them.

They act as intermediaries between security issuers and investors and help new firms to go
public. They either buy all the available shares at a price estimated by their experts and resell
them to public or sell shares on behalf of the issuer and take commission on each share.

Description: Investment banking is among the most complex financial mechanisms in the

world. They serve many different purposes and business entities. They provide various types
of financial services, such as proprietary trading or trading securities for their own accounts,
mergers and acquisitions advisory which involves helping organisations in M&As,; leveraged
finance that involves lending money to firms to purchase assets and settle acquisitions,
restructuring that involves improving structures of companies to make a business more
efficient and help it make maximum profit, and new issues or IPOs, where these banks help
new firms go public.

Let’s understand how an investment bank earns money by providing acquisition advisories.

Think of company ABC buying another company XYZ. ABC is not sure how much company
XYZ is really worth and what will be the long-term benefits in terms of revenues, costs, etc.
In this scenario, the investment bank will go through the process of due diligence to
determine the value of the company, settle the deal by helping ABC prepare necessary
documents and advising it on the appropriate timing of the deal.

Here the investment bank works on the buy side and some other investment banks may be
working on the sell side to help XYZ. The bigger the deal size, the more commission the
bank will earn.

Bank of America, Barclays Capital, Citigroup Investment Banking, Deutsche Bank, and JP
Morgan are some of the largest investment banks in India.
 Roles or Function of Investment Banking
Investment Banks performs various different type of function in the economy by offering
different financial services to their clients such as helping the corporations in finding the
investor for obtaining the debt finance, underwriting of the stock issues, working as the
financial advisor, handling of the mergers and acquisitions etc.
1) IPOs
This investment banking function, i.e., IPO is an initial public offering wherein a
company hires an investment bank to issue IPO.
Below are the steps followed by a company for its IPO:-

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a. Before the issuance of IPO company hire an investment bank. This bank is chosen
based on different criteria like market reputation, industrial experience, quality of
research and distribution channels, etc.
b. Selected banks so underwriting where it acts as a broker between investors and
issuing company.
c. The investment bank works out on financial detail of the IPO in the underwriting
agreement.
d. Post that company files registration statement along with underwriting agreement with
SEC.
e. Post-approval of IPO by SEC underwriter and issuing company decide offer price and
a number of shares to be sold.
f. After issuance, the bank carries out aftermarket stabilization in which that bank
analyzes aftermarket stabilization and creates a market for the stock.
g. The final stage is a transition to market competition. After 25 days period, the bank
provides an estimate regarding the valuation and earning of the issuing company.

Investment bank helps a company to set everything and list IPO in a stock exchange.
IPO is one of the major investment banking functions. This bank, in return, charges a
commission from a company.
2) Merger and Acquisition
Merger and Acquisitions is the area of corporate finances, management, and strategy
dealing with purchasing or joining with other companies. An investment bank, in
return, charges fees for M&A. M&A company hires a bank for mergers and
acquisitions
3) Risk Management
Risk Management from the name itself, it is clear that its management of risk involves, it is a
continuous process as capital is involved, it set a limit to avoid loss in trade. Investment
banks help a company in the following ways:-

 Investment bank helps a company to manage financial risk in term of currency, loans,

liquidity, etc.
 This bank helps a company to recognize the loss area.
 This credit risk control credit risk investment spreads out counterparties, and banks
choose standard exchange for trading.
 There are different risks like business risk, investment risk, legal & compliance risk,
and operational risk, which are internally controlled by an investment bank.

Risk management is done at every level by investment banks as it highlights what the risks
are and how it can be handled.

4) Research

This equity research investment banking function is one of the most important investment
banking function is research. This research helps provide a rating to the company to help
investors to make a decision of investment. Research reports tell whether to buy, sell, or
to hold the base on a rating of a company. Through this, one can know the worthiness of
the company. Research is done by analyzing and comparing various reports and

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performance reports of the company. Investment bank primary work is research, and
these researches are of multiple types like equity research, fixed income research,
macroeconomic research, qualitative research, etc. Investment bank shares these reports
with clients which helps an investor to generate profit through trading and sales.

5) Structuring of Derivatives

For this Investment banking function, i.e., structuring of derivatives, investment bank
needs a strong technical team working on such a complex structure of derivatives.
Derivatives product offer a high rate of return and good margin; hence a lot of risks is
involved with it. Investment bank prepares these derivatives with a strategy based on a
single as well as multiple securities.

This bank adds features to it, like in bonds. It provides future and options derivative etc.
Investment bank designs securities with different derivatives options. The main reason to
design such a product is to attract investors and to increase the profit margin. There is
another derivative also available in the market; it helps to generate a good return to
investors.

6) Merchant Banking

This investment banking function is one of the private activities of the investment bank where
the bank also does consultancy for their clients. They provide consultancy in a matter of
financial, marketing, legal, and managerial. It acts as a financial engineer for business.

Merchant banking has the below functions:-

 Raising finance for a client

 Broker in Stock exchange
 Project management
 Money market operations
 Leasing service
 Portfolio management
 Handling government consent for industrial projects
 Managing public issue of a company
 Special assistance to small companies and entrepreneurs

There are multiple other services provided by investment banks to their clients. This bank
charges consultancy fees from investors.

7) Investment management

This investment banking function is a core job of an investment bank to guide the
investor to purchase, manage his portfolio, and to trade various securities. Investment

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bank prepares reports based on company performance, and through this it investment
bank makes a decision on financial securities. Investment advice is provided based on the
client’s objective, the client’s risk appetite, investment amount, and time period.  Based
on the customer segment, investment management is divided like Private clients, Private
wealth management, wealth management. Here, an investment bank manages a portfolio
of customers and also provides tips to investors whether to sell stocks or to buy stocks or
to hold stocks.

 Merchant Banker

Merchant bankers, lead managers and registrars play a key role and facilitate primary
market activities by their advice and guidance. Let us discuss the role of merchant
bankers in this article.

As per SEBI rules, a merchant banker refers to,

“any person who is engaged in the business of issue management either by making
arrangement regarding buying, selling or subscribing to securities or acting as manager,
consultant or rendering corporate advisory services in relation to such issue
management”.

The Webster’s New Collegiate Dictionary defines merchant bank as,

“that specializes in bankers’ acceptances and in underwriting or syndicating equity or

bond issues”

Role of merchant banker

1) Raising finance

Merchant Bankers help their clients in raising finance by way of issue of a debenture, shares,
bank loans, etc. They tap both the domestic as well as the international markets. Finance
raised by this method may be used for commencing a new project or business or it may even
be used for expansion and modernization of an existing business.

2) Promotional activities

In India, merchant bankers play the role of promoter of industrial enterprises. They help
entrepreneurs in conceiving ideas, identifying projects, preparation of feasibility reports,

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getting Government approvals as well as incentives, etc. Merchant bankers may, at times,
also provide assistance in financial and technical collaborations and i joint ventures.

3) Brokers in stock exchanges

Merchant bankers buy and sell shares in the stock exchange on behalf of the clients. They
additionally conduct researches on equity shares, advise the clients on the share to be
purchased, the time of purchase, quantity of such purchase and the time for selling these
shares. Mutual funds offer merchant banking services, large brokers, investment banks, and
venture capitals.

4) Project management

Merchant bankers offer help to clients in several ways in the process of project management.
They offer advice regarding the location of the project, preparation of project report, in
carrying out feasibility studies, planning out the financing of the project, tapping sources of
such finance, information regarding incentives and concessions from the government

5) Advise on modernisation and expansion

Merchant bankers advise on amalgamations, mergers, acquisitions, takeovers, foreign

collaborations, diversification of business, technology up-gradation, joint-ventures, etc.

6) Managing public issue

They provide the following services in the above-mentioned process:

 the timing of the public issue

 the size of the issue
 the price of the issue
 acting in the capacity of manager to the issue
 assisting in receiving applications as well as allotment of securities
 appointment of brokers as well as underwriters of the issue
 listing of the shares on the relevant stock exchange.

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Initially, merchant bankers mostly performed the function of managing new public issues of
corporate securities of either newly formed companies or existing companies and foreign
companies in the process of dilution of equity provided under the FERA[20]. Here, they acted
as sponsors of issues. They get the permission of the Controller of Capital Issues (which is
now the SEBI). They also provide several other services to guarantee success in the process
of marketing of securities. These services include, preparation of the prospectus, making
underwriting arrangements, appointing registrars, bankers, brokers to the issue, arranging for
advertising and publicity as well as compliance with the listing requirements of the relevant
stock exchanges, etc. A merchant banker acts as experts on the terms, type and timing of the
issues of the corporate securities and makes them suitable for investors and provides freedom
and flexibility to issuing companies.

7) Credit syndication

A merchant banker provides specialized services in the stages of preparation of a project, the
loan applications required for the raising of short-term and long- term credit from various
banks and financials institutions, etc. They help in managing Euro-issues and raising funds
abroad.

8) Handling government consent for industrial projects

A merchant banker completes all formalities for his or her client, about government
permission to expand and modernize business (necessary for companies) and commencing
new businesses (necessary for business people).

9) Special assistance to entrepreneurs and small companies

Merchant banker advises entrepreneurs and small companies on availability and existence of
business opportunities, concessions, incentives and government policies and helps them to
take advantage of this option available to them, to the best of their capabilities

10) Services to PSU’s

Merchant banker offers numerous services to public sector undertakings and units and their
public utilities. They assist in raising capital (long-term), in the marketing of securities, in

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foreign collaborations as well as in arranging for long-term finances from lending

institutions.

11) Revival of sick units

A merchant bank helps in reviving sick industrial units. They negotiate with various agencies
such as banks, long-term lending institutions, and the Board for Industrial and Financial
Reconstruction (BIFR). They also plan and execute full revival packages.

12) Portfolio management of sick units

Merchant bankers offer revival services to companies that issue the securities as well as
investors. These bankers advise clients, which are usually institutional investors, on
investment decisions. They undertake purchase and sale of securities to provide them with
portfolio management services. Some of these bankers are operating mutual funds as well as
offshore funds.

13) Corporate restructuring

These services of merchant bankers include mergers, acquisitions (about existing units), the
sale of units and disinvestment. These procedures demand proper negotiations, thorough
preparation of numerous documents and completion of lengthy legal formalities. Merchant
bankers fulfill all these formalities on behalf of the clients.

Money market operations

A merchant bank deals with as well as underwrites short-term instruments like:

 government bonds
 certificate of deposit issued by banks and financial institutions
 commercial paper issued by large corporate firms
 treasury bills issued by the government (in India by the Reserve Bank of India)

14) Leasing and finance services

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Merchant banks also assist leasing and financing services. A lease refers to a contract that
exists between a lessor and a lessee, by which the lessor permits the use of a specific asset
that belongs to him or her(like equipment, land) by the lessee for a specified period. There is
a fee charged by the lessor charges which is referred to asthe rentals. Several merchant
bankers offer leasing and financing facilities to the customers. Some banks also keep venture
capital funds to assist entrepreneurs. These banks also help the companies to raise finance
through public deposits.

15) Servicing issues

Merchant bankers now also act as the paying agents for service of the debt- securities and act
as the registrars as well as the transfer agents. In this way, they maintain the registers of the
shareholders and the debenture holders and also arrange the payment of dividend and or the
interest that is due to them.

16) Management of dividend and interest

Merchant banks help the clients in the management of the interest on the debentures or loans,
as well as the dividend on the shares. In addition to this, they advise the client with respect to
the timings (whether interim or annual) of the dividend as well as the rate of the dividend

17) Other services

Along with all the services mentioned above, the merchant bankers also offer certain other
specialized services such as advisory services on matters such as mergers, amalgamations, tax
related matters, on the matter of recruitment of executives, the cost of audit as well as its
management among several others. The scope of functions, activities and the services
provided by the merchant bankers are ever increasing and growing with the constant
development in the money market.

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