Investment banks provide a wealth of critical services to our economy. One important role of the investment bank is to assist public and private corporations in raising funds in the capital markets. A second service is in providing strategic advisory services for mergers, acquisitions and other types of financial transactions. They also act as intermediaries in trading for clients. Investment banks differ from commercial banks, which take deposits and make commercial and retail loans. The focus of this paper will be to describe the investment banking process including the function of portfolio construction.
To better understand the investment banks role it is important to distinguish between what is known as the primary and secondary markets. Secondary markets are defined as "markets for existing assets that are currently traded between investors" (Hirt and Block, 2006). The secondary markets are important because they create prices and provide liquidity. Without secondary markets investors would have no avenue to sell their assets eliminating liquidity. "Primary markets are distinguished by the flow of funds between the market participants" (Hirt and Block, 2006). Instead of trading between investors as in the secondary markets, participants in the primary market buy their assets directly from the source of the asset.
Investment banks comprise the most active participants in the primary market. Investment Banks act as the intermediary between the public and the issuer of the security. Corporations that need to raise money will issue securities. Investment banks will become the underwriter. The bank will purchase all the shares at a fixed price that is discounted from the public price, eliminating the risk that the corporation would assume if unable to sell a ...