What do investment banks actually do? - MoneyWeek Investment Tutorials

Summary

This video explains the key activities of investment banks, focusing on five main functions: proprietary trading, market making, mergers and acquisitions (M&A) advisory, new issue underwriting, and product structuring. It contrasts these high-risk, high-reward activities with the safer retail banking operations. The video highlights how investment banks generate substantial profits through these functions, justifying their high fees and bonuses, while also acknowledging the risks involved. However, whether these activities truly justify large bonuses is left as an open question.

Takeaways

• 💼 Investment banks have been in the spotlight due to discussions about their large bonuses and how they justify paying them.
• 🏦 Many banks today combine both retail and investment banking, but some, like Goldman Sachs, focus primarily on investment banking.
• 💳 Retail banking deals with loans, mortgages, and savings accounts, while investment banking is seen as riskier and more profitable.
• 📊 One key function of investment banks is proprietary trading, where they use their own funds to gamble on markets and potentially make large profits.
• 💹 Investment banks also engage in market making, ensuring that there are buyers and sellers in the market, often acting as intermediaries in trades.
• 🤝 Mergers and acquisitions (M&A) advisory is another major role, where banks help companies merge, acquire, and navigate the complex regulations of deals.
• 💰 Investment banks assist in corporate events, particularly by helping companies raise funds through new issues, such as stocks or bonds.
• 📈 Underwriting is a significant aspect where investment banks commit to buying shares in new issues if the market doesn't absorb them, taking on risk for a fee.
• 🛠 Structuring financial products is another service provided, where investment banks design complex investment products tailored to the needs of clients.
• 💸 Despite the high-risk activities and fees, there's ongoing debate about whether these activities justify the enormous bonuses often paid to investment bankers.

Q & A

What is the main focus of the video?

The video focuses on explaining the core activities of investment banks and how these activities are used to justify the large bonuses paid to their star traders.

What are the two basic functions of banks mentioned in the video?

The two basic functions of banks mentioned are retail banking and investment banking.

How do investment banks differ from retail banks?

Retail banks primarily handle mortgages, loans, and savings for individuals and businesses, while investment banks focus on higher-risk activities like trading, market making, and advising companies on mergers and acquisitions.

What is proprietary (prop) trading, and how does it work?

Proprietary trading is when investment banks use their own funds to gamble on financial markets such as currencies, commodities, and bonds in an attempt to generate profits.

What is market making, and why is it important?

Market making involves investment banks facilitating trades by ensuring there are always buyers and sellers for a stock, helping to maintain liquidity in financial markets.

What role do investment banks play in mergers and acquisitions (M&A)?

Investment banks advise companies on M&A deals, offering expertise on deal timing, structuring, regulatory requirements, due diligence, and publicizing the transaction. They earn fees based on the size of the deal.

What are corporate events and new issues in the context of investment banking?

Corporate events, such as new issues, involve investment banks helping companies raise capital by issuing shares or bonds. Banks advise on timing, pricing, marketing, and may even underwrite the issue to ensure it is fully subscribed.

What are structured products, and why do some investors consider them risky?

Structured products are financial instruments designed to offer specific payouts based on market conditions. They often promise a return of the initial investment under certain conditions, but investors may forgo potential gains or interest in exchange for limited upside, making them risky.

How do investment banks justify the large bonuses they pay their employees?

Investment banks argue that the activities they engage in, such as proprietary trading, M&A advisory, and market making, are high-risk and require exceptional skill, justifying the large fees and bonuses paid to those involved.

What are the five core activities of investment banks mentioned in the video?

The five core activities are proprietary trading, market making, mergers and acquisitions (M&A) advisory, corporate events and new issues, and structuring products.