Chapterg1:gWhatgisgangInvestmentgBank
?gThegplayers
<gPAGEg1gOFg1>
Whatgisginvestmentgbanking?gIsgitginvesting?gIsgitgbanking?gReally,gitgisgneither.gInvestmentgbanking,gorgI-
gbanking,gasgitgisgoftengcalled,gisgthegterm gusedgtogdescribegthegbusinessgofgraisinggcapitalgforgcompanies.gCapi
talgessentiallygmeansgmoney.gCompaniesgneedgcashgingordergtoggrowgandgexpandgtheirgbusinesses;ginvestme
ntgbanksgsellgsecuritiesgtogpublicginvestorsgingordergtograisegthisgcash.gThesegsecuritiesgcangcomegingthegformgof
gstocksgorgbonds,gwhichgwegwillgdiscussgingdepthglater.
ThegPlayers
ThegbiggestginvestmentgbanksgincludegGoldmangSachs,gMerrillgLynch,gMorgangStanleygDeangWitter,gSalomong
SmithgBarney,gDonaldson,gLufking&gJenrette,gJ.P.gMorgangandgLehmangBrothers,gamonggothers.gOfgcourse,gt
hegcompleteglistgofgI-
banksgisgmoregextensive,gbutgthegfirmsglistedgabovegcompetegforgthegbiggestgdealsgbothgingthegU.S.gandgworld
wide.
Youghavegprobablygheardgofgmanygofgthesegfirms,gandgperhapsghavegagbrokeragegaccountgwithgonegofgthem.g
WhilegbrokersgfromgthesegfirmsgcovergeverygcitygingthegU.S.,gthegheadquartersgofgeverygonegofgthesegfirmsgisging
NewgYorkgCity,gthegepicentergofgthegI-
bankingguniverse.gItgisgimportantgtogrealizegthatginvestmentgbankinggandgbrokerageggoghand-in-
hand,gbutgthatgbrokersgaregonegsmallgcoggingtheginvestmentgbankinggwheel.gAsgwegwillgcovergingdetailglater,gbr
okersgsellgsecuritiesgthatgagfirmgunderwritesgandgmanagegthegportfoliosgofgretailginvestors.
ManygangI-
bankinggintervieweegasks,g"Whichgfirmgisgthegbest?"gTheganswer,glikegmanygthingsginglife,gisgunclear.gEachgfirmgl
istedgabovegcertainlygcangproducegreamsgofgpapergandgdatagattestinggtogitsgdominance,gandgmostghavegsever
algstrengths.gButgnogsinglegfirmgrulesgingeverygaspectgofgbanking.gMerrillgleadsgingtotalgunderwritinggvolume,gbu
tgtrailsgDLJginghigh-
yield.gGoldmangSachs'greputationgingequitygunderwritinggandgM&Agadvisorygisgstellar,gbutgitglagsgthegcompetiti
ongingthegasset-
backedgdebtgbusiness.gThegfollowinggpagesgcontaingthegrankingsgofginvestmentgbanksg(commonlygcalledgleag
uegtables)gingseveralgcategories.gAllgingall,geverygfirmghasgitsgowngprosgandgcons,gandgchoosinggonegbasedgongr
eputationgalonegwouldgbegfoolhardy.gInggeneral,gthegpeoplegyougworkgwithgaregthegmostgimportantgpartgofgchoo
singgagfirmg-gnogonegevergreportedglovinggtheirgjobgbecausegtheirgfirmgrankedgnumbergonegingthegindustry.
Theggame
<gPAGEg1gOFg1>
Generally,gthegbreakdowngofganginvestmentgbankgincludesgthegfollowinggareas:
CorporategFinance
Thegbreadgandgbuttergofgagtraditionalginvestmentgbank,gcorporategfinanceggenerallygperformsgtwogdifferentgfun
ctions:g1)gMergersgandgacquisitionsgadvisorygandg2)gUnderwriting.gOngthegmergersgandgacquisitionsg(M&A)gad
visinggsidegofgcorporategfinance,gbankersgassistgingnegotiatinggandgstructuringgagmergergbetweengtwogcompan
ies.gIf,gforgexample,gagcompanygwantsgtogbuyganothergfirm,gthenganginvestmentgbankgwillghelpgfinalizegthegpurc
hasegprice,gstructuregthegdeal,gandggenerallygensuregagsmoothgtransaction.gThegunderwritinggfunctiongwithingco
rporategfinanceginvolvesgshepherdinggthegprocessgofgraisinggcapitalgforgagcompany.gIngtheginvestmentgbankingg
world,gcapitalgcangbegraisedgbygsellinggeithergstocksgorgbondsgtoginvestors.
Sales
Salesgisganothergcoregcomponentgofganyginvestmentgbank.gSalespeoplegtakegthegformgof:g1)gthegclassicgretailgbro
1
,ker,g2)gtheginstitutionalgsalesperson,gorg3)gthegprivategclientgservicegrepresentative.gBrokersgdevelop
2
,relationshipsgwithgindividualginvestorsgandgsellgstocksgandgstockgadvicegtogthegaveragegJoe.gInstitutionalgsales
peoplegdevelopgbusinessgrelationshipsgwithglargeginstitutionalginvestors.gInstitutionalginvestorsgaregthosegwhogm
anageglargeggroupsgofgassets,gforgexamplegpensiongfundsgorgmutualgfunds.gPrivategClientgServiceg(PCS)grepr
esentativesgliegsomewheregbetweengretailgbrokersgandginstitutionalgsalespeople,gprovidinggbrokeragegandgmo
neygmanagementgservicesgforgextremelygwealthygindividuals.gSalespeoplegmakegmoneygthroughgcommission
sgongtradesgmadegthroughgtheirgfirms.
Trading
Tradersgalsogprovidegagvitalgrolegforgtheginvestmentgbank.gTradersgfacilitategthegbuyinggandgsellinggofgstock,gb
onds,gorgothergsecuritiesgsuchgasgcurrencies,geithergbygcarryingganginventorygofgsecuritiesgforgsalegorgbygexecu
tinggaggivengtradegforgagclient.gTradersgdealgwithgtransactionsglargegandgsmallgandgprovidegliquidityg(thegabilityg
togbuygandgsellgsecurities)gforgthegmarket.g(Thisgisgoftengcalledgmakinggagmarket.)gTradersgmakegmoneygbygpur
chasinggsecuritiesgandgsellinggthemgatgagslightlyghighergprice.gThisgpricegdifferentialgisgcalledgtheg"bid-
gask gspread."
Research
Researchganalystsgfollowgstocksgandgbondsgandgmakegrecommendationsgongwhethergtogbuy,gsell,gorgholdgth
osegsecurities.gStockganalystsg(knowngasgequityganalysts)gtypicallygfocusgongonegindustrygandgwillgcovergupgtog
20gcompanies'gstocksgatganyggivengtime.gSomegresearchganalystsgworkgongthegfixedgincomegsidegandgwillgco
vergagparticulargsegment,gsuchgasghighgyieldgbondsgorgU.S.gTreasurygbonds.gSalespeoplegwithingthegI-
bankgutilizegresearchgpublishedgbyganalystsgtogconvincegtheirgclientsgtogbuygorgsellgsecuritiesgthroughgtheirgfirm
.
Corporategfinancegbankersgrelygongresearchganalystsgtogbegexpertsgingthegindustrygingwhichgtheygaregworking.gR
eputablegresearchganalystsgcanggenerategsubstantialgcorporategfinancegbusinessgasgwellgasgsubstantialgtradin
ggactivity,gandgthusgaregangintegralgpartgofganyginvestmentgbank.
Syndicate
Theghubgofgtheginvestmentgbankinggwheel,gsyndicategprovidesgagvitalglinkgbetweengsalespeoplegandgcorporategf
inance.gSyndicategexistsgtogfacilitategthegplacinggofgsecuritiesgingagpublicgoffering,gagknock-downgdrag-
outgaffairgbetweengandgamonggbuyersgofgofferingsgandgtheginvestmentgbanksgmanaginggthegprocess.gIngagcorp
orategorgmunicipalgdebtgdeal,gsyndicategalsogdeterminesgthegallocationgofgbonds.gThegbreakdowngofgthesegfund
amentalgareasgdiffersgslightlygfromgfirmgtogfirm,gbutgtypicallyganginvestmentgbankgwillghavegthegfollowinggareas:
Thegfunctionsgofgallgofgthesegareasgwillgbegdiscussedgingmuchgmoregdetailglatergingthegbook.gIngthisgoverviewgsec
tion,gwegwillgcovergthegnutsgandgboltsgofgthegbusiness,gprovidinggangoverviewgofgthegstockgandgbondgmarkets,g
andghowgangI-bankgoperatesgwithingthem.
Chapterg2:gCommercialgBanking,gInvestmentgBanking,gandgAssetgManagement
Commercialgbankinggvs.ginvestmentgbanking
<gPAGEg1gOFg1>
Beforegdescribingghowganginvestmentgbankgoperates,glet'sgbackgupgandgstartgbygdescribinggtraditionalgcommer
cialgbanking.gCommercialgandginvestmentgbankinggsharegmanygaspects,gbutgalsoghavegmanygfundamentalgdiff
erences.gAftergagquickgoverviewgofgcommercialgbanking,gwegwillgbuildgupgtogagfullgdiscussiongofgwhatgI-
bankinggentails.
Althoughgthegbarriersgbetweenginvestmentgandgcommercialgbanksghavegessentiallygbeengremovedgbygthegrec
entgpassagegofgthegGramm-Leach-
BlileygFinancialgServicesgModernizationgActgofg1999,gwegwillgforgnowgexaminegthegtraditionalgmodelgofgthegco
mmercialgbankinggindustrygandgcomparegitgtoginvestmentgbanking.gWegwillgthenginvestigateghowgthegnewglegisla
tiongaffectsgcommercialgandginvestmentgbankinggorganizations.gAlso,gwegwillgdistinguishgbetweengthegbuy-
sidegandgthegsell-sidegofgthegsecuritiesgindustry.
3
, Commercialgbankinggvs.ginvestmentgbanking
Whilegregulationghasgchangedgthegbusinessesgingwhichgcommercialgandginvestmentgbanksgmaygnowgparticipa
te,gthegcoregaspectsgofgthesegdifferentgbusinessesgremaingintact.gIngothergwords,gthegdifferencegbetweenghowg
agtypicalginvestmentgbankgandgagtypicalgcommercialgoperategbankgisgsimple:gAgcommercialgbankgtakesgdeposits
gforgcheckinggandgsavingsgaccountsgfrom gconsumersgwhileganginvestmentgbank gdoesgnot.gWe'llg begingexamini
nggwhatgthisgmeansgbygtakinggaglookgatgwhatgcommercialgbanksgdo.
Commercialgbanks
Agcommercialgbankgmayglegallygtakegdepositsgforgcheckinggandgsavingsgaccountsgfromgconsumers.gThegfeder
alggovernmentgprovidesginsurancegguaranteesgongthesegdepositsgthroughgthegFederalgDepositgInsurancegCorp
orationg(thegFDIC),gongamountsgupgtog$100,000.gToggetgFDICgguarantees,gcommercialgbanksgmustgfollowgagmy
riadgofgregulations.
Thegtypicalgcommercialgbankinggprocessgisgfairlygstraightforward.gYougdepositgmoneygintogyourgbank,gandgthe
gbank gloansgthatgmoneygtogconsumersgandgcompaniesgingneedgofgcapitalg(cash).gYougborrowgtogbuygaghouse,g
financegagcar,gorgfinancegangadditiongtogyourghome.gCompaniesgborrowgtogfinancegtheggrowthgofgtheirgcompanyg
orgmeetgimmediategcashgneeds.gCompaniesgthatgborrowgfromgcommercialgbanksgcangrangegingsizegfromgthegd
rygcleanergongthegcornergtogagmultinationalgconglomerate.
Privategcontracts
Importantly,gloansgfromgcommercialgbanksgaregstructuredgasgprivateglegallygbindinggcontractsgbetweengtwogpa
rtiesg-
gthegbank gandg youg(orgthegbank gandgagcompany). gBanksgwork gwithgtheirgclientsgtogindividuallygdeterminegthegt
ermsgofgthegloans,gincludinggthegtimegtogmaturitygandgtheginterestgrategcharged.gYourgindividualgcreditghistoryg(
orgcreditgriskgprofile)gdeterminesgthegamountgyougcangborrowgandghowgmuchginterestgyougaregcharged.gPerha
psgyougneedgtogborrowg$200,000goverg15gyearsgtogfinancegthegpurchasegofgyourghome,gorgmaybegyougneedg$
30,000govergfivegyearsgtogfinancegthegpurchasegofgagcar.gMaybegforgthegfirstgloan,gyougandgthegbankgwillgagreeg
thatgyougpayganginterestgrategofg7.5gpercent;gperhapsgforgthegcargloan,gtheginterestgrategwillgbeg11gpercent.gTheg
samegprocessgappliesgtogloansgtogcompaniesgasgwellg-
gthegratesgaregdeterminedgthroughgag negotiationgbetweengthegbankgandgthegcompany.
Let'sgtakegagminutegtogunderstandghowgagbankgmakesgitsgmoney.gOngmostgloans,gcommercialgbanksgingthe
U.S.gearnginterestganywheregfromg5gtog14gpercent.gAskgyourselfghowgmuchgyourgbankgpaysgyougongyourgdepo
sitsg-
gthegmoneygthatgitgusesgtogmakegloans.gYougprobablygearngagpaltryg1gpercentgongagcheckinggaccount,g ifganything
,gandgmaybeg2gtog3gpercentgongagsavingsgaccount.gCommercialgbanksgthusgmakeggobsgofgmoney,gtakinggadva
ntagegofgtheglargegspreadgbetweengtheirgcostgofgfundsg(1gpercent,gforgexample)gandgtheirgreturngongfundsgloane
dg(ranginggfromg5gtog14gpercent).
Investmentgbanks
Anginvestmentgbankgoperatesgdifferently.gAnginvestmentgbankgdoesgnotghaveganginventorygofgcashgdepositsgtogl
endgasgagcommercialgbankgdoes.gIngessence,ganginvestmentgbankgactsgasgangintermediary,gandgmatchesgsell
ersgofgstocksgandgbondsgwithgbuyersgofgstocksgandgbonds.
Note,ghowever,gthatgcompaniesguseginvestmentgbanksgtowardgthegsamegendgasgtheygusegcommercialgbanks.gIfg
agcompanygneedsgcapital,gitgmayggetgagloangfromgagbank,gorgitgmaygaskganginvestmentgbankgtogsellgequitygorgd
ebtg(stocksgorgbonds).gBecausegcommercialgbanksgalreadyghavegfundsgavailablegfromgtheirgdepositorsgandgan
ginvestmentgbank gdoesgnot,gangI-
bankgmustgspendgconsiderablegtimegfindingginvestorsgingordergtogobtaingcapitalgforgitsgclient.
Publicgsecurities
Investmentgbanksgtypicallygsellgpublicgsecuritiesg(asgopposedgprivategloangagreements).gTechnically,gsecuritie
sgsuchgasgMicrosoftgstockgorgFordgAAAgbonds,grepresentggovernment-
approvedgstocksgorgbondsgthatgaregtradedgeithergongagpublicgexchangegorgthroughgangapprovedgdealer.gThegde
alergisgtheginvestmentgbank.
4
?gThegplayers
<gPAGEg1gOFg1>
Whatgisginvestmentgbanking?gIsgitginvesting?gIsgitgbanking?gReally,gitgisgneither.gInvestmentgbanking,gorgI-
gbanking,gasgitgisgoftengcalled,gisgthegterm gusedgtogdescribegthegbusinessgofgraisinggcapitalgforgcompanies.gCapi
talgessentiallygmeansgmoney.gCompaniesgneedgcashgingordergtoggrowgandgexpandgtheirgbusinesses;ginvestme
ntgbanksgsellgsecuritiesgtogpublicginvestorsgingordergtograisegthisgcash.gThesegsecuritiesgcangcomegingthegformgof
gstocksgorgbonds,gwhichgwegwillgdiscussgingdepthglater.
ThegPlayers
ThegbiggestginvestmentgbanksgincludegGoldmangSachs,gMerrillgLynch,gMorgangStanleygDeangWitter,gSalomong
SmithgBarney,gDonaldson,gLufking&gJenrette,gJ.P.gMorgangandgLehmangBrothers,gamonggothers.gOfgcourse,gt
hegcompleteglistgofgI-
banksgisgmoregextensive,gbutgthegfirmsglistedgabovegcompetegforgthegbiggestgdealsgbothgingthegU.S.gandgworld
wide.
Youghavegprobablygheardgofgmanygofgthesegfirms,gandgperhapsghavegagbrokeragegaccountgwithgonegofgthem.g
WhilegbrokersgfromgthesegfirmsgcovergeverygcitygingthegU.S.,gthegheadquartersgofgeverygonegofgthesegfirmsgisging
NewgYorkgCity,gthegepicentergofgthegI-
bankingguniverse.gItgisgimportantgtogrealizegthatginvestmentgbankinggandgbrokerageggoghand-in-
hand,gbutgthatgbrokersgaregonegsmallgcoggingtheginvestmentgbankinggwheel.gAsgwegwillgcovergingdetailglater,gbr
okersgsellgsecuritiesgthatgagfirmgunderwritesgandgmanagegthegportfoliosgofgretailginvestors.
ManygangI-
bankinggintervieweegasks,g"Whichgfirmgisgthegbest?"gTheganswer,glikegmanygthingsginglife,gisgunclear.gEachgfirmgl
istedgabovegcertainlygcangproducegreamsgofgpapergandgdatagattestinggtogitsgdominance,gandgmostghavegsever
algstrengths.gButgnogsinglegfirmgrulesgingeverygaspectgofgbanking.gMerrillgleadsgingtotalgunderwritinggvolume,gbu
tgtrailsgDLJginghigh-
yield.gGoldmangSachs'greputationgingequitygunderwritinggandgM&Agadvisorygisgstellar,gbutgitglagsgthegcompetiti
ongingthegasset-
backedgdebtgbusiness.gThegfollowinggpagesgcontaingthegrankingsgofginvestmentgbanksg(commonlygcalledgleag
uegtables)gingseveralgcategories.gAllgingall,geverygfirmghasgitsgowngprosgandgcons,gandgchoosinggonegbasedgongr
eputationgalonegwouldgbegfoolhardy.gInggeneral,gthegpeoplegyougworkgwithgaregthegmostgimportantgpartgofgchoo
singgagfirmg-gnogonegevergreportedglovinggtheirgjobgbecausegtheirgfirmgrankedgnumbergonegingthegindustry.
Theggame
<gPAGEg1gOFg1>
Generally,gthegbreakdowngofganginvestmentgbankgincludesgthegfollowinggareas:
CorporategFinance
Thegbreadgandgbuttergofgagtraditionalginvestmentgbank,gcorporategfinanceggenerallygperformsgtwogdifferentgfun
ctions:g1)gMergersgandgacquisitionsgadvisorygandg2)gUnderwriting.gOngthegmergersgandgacquisitionsg(M&A)gad
visinggsidegofgcorporategfinance,gbankersgassistgingnegotiatinggandgstructuringgagmergergbetweengtwogcompan
ies.gIf,gforgexample,gagcompanygwantsgtogbuyganothergfirm,gthenganginvestmentgbankgwillghelpgfinalizegthegpurc
hasegprice,gstructuregthegdeal,gandggenerallygensuregagsmoothgtransaction.gThegunderwritinggfunctiongwithingco
rporategfinanceginvolvesgshepherdinggthegprocessgofgraisinggcapitalgforgagcompany.gIngtheginvestmentgbankingg
world,gcapitalgcangbegraisedgbygsellinggeithergstocksgorgbondsgtoginvestors.
Sales
Salesgisganothergcoregcomponentgofganyginvestmentgbank.gSalespeoplegtakegthegformgof:g1)gthegclassicgretailgbro
1
,ker,g2)gtheginstitutionalgsalesperson,gorg3)gthegprivategclientgservicegrepresentative.gBrokersgdevelop
2
,relationshipsgwithgindividualginvestorsgandgsellgstocksgandgstockgadvicegtogthegaveragegJoe.gInstitutionalgsales
peoplegdevelopgbusinessgrelationshipsgwithglargeginstitutionalginvestors.gInstitutionalginvestorsgaregthosegwhogm
anageglargeggroupsgofgassets,gforgexamplegpensiongfundsgorgmutualgfunds.gPrivategClientgServiceg(PCS)grepr
esentativesgliegsomewheregbetweengretailgbrokersgandginstitutionalgsalespeople,gprovidinggbrokeragegandgmo
neygmanagementgservicesgforgextremelygwealthygindividuals.gSalespeoplegmakegmoneygthroughgcommission
sgongtradesgmadegthroughgtheirgfirms.
Trading
Tradersgalsogprovidegagvitalgrolegforgtheginvestmentgbank.gTradersgfacilitategthegbuyinggandgsellinggofgstock,gb
onds,gorgothergsecuritiesgsuchgasgcurrencies,geithergbygcarryingganginventorygofgsecuritiesgforgsalegorgbygexecu
tinggaggivengtradegforgagclient.gTradersgdealgwithgtransactionsglargegandgsmallgandgprovidegliquidityg(thegabilityg
togbuygandgsellgsecurities)gforgthegmarket.g(Thisgisgoftengcalledgmakinggagmarket.)gTradersgmakegmoneygbygpur
chasinggsecuritiesgandgsellinggthemgatgagslightlyghighergprice.gThisgpricegdifferentialgisgcalledgtheg"bid-
gask gspread."
Research
Researchganalystsgfollowgstocksgandgbondsgandgmakegrecommendationsgongwhethergtogbuy,gsell,gorgholdgth
osegsecurities.gStockganalystsg(knowngasgequityganalysts)gtypicallygfocusgongonegindustrygandgwillgcovergupgtog
20gcompanies'gstocksgatganyggivengtime.gSomegresearchganalystsgworkgongthegfixedgincomegsidegandgwillgco
vergagparticulargsegment,gsuchgasghighgyieldgbondsgorgU.S.gTreasurygbonds.gSalespeoplegwithingthegI-
bankgutilizegresearchgpublishedgbyganalystsgtogconvincegtheirgclientsgtogbuygorgsellgsecuritiesgthroughgtheirgfirm
.
Corporategfinancegbankersgrelygongresearchganalystsgtogbegexpertsgingthegindustrygingwhichgtheygaregworking.gR
eputablegresearchganalystsgcanggenerategsubstantialgcorporategfinancegbusinessgasgwellgasgsubstantialgtradin
ggactivity,gandgthusgaregangintegralgpartgofganyginvestmentgbank.
Syndicate
Theghubgofgtheginvestmentgbankinggwheel,gsyndicategprovidesgagvitalglinkgbetweengsalespeoplegandgcorporategf
inance.gSyndicategexistsgtogfacilitategthegplacinggofgsecuritiesgingagpublicgoffering,gagknock-downgdrag-
outgaffairgbetweengandgamonggbuyersgofgofferingsgandgtheginvestmentgbanksgmanaginggthegprocess.gIngagcorp
orategorgmunicipalgdebtgdeal,gsyndicategalsogdeterminesgthegallocationgofgbonds.gThegbreakdowngofgthesegfund
amentalgareasgdiffersgslightlygfromgfirmgtogfirm,gbutgtypicallyganginvestmentgbankgwillghavegthegfollowinggareas:
Thegfunctionsgofgallgofgthesegareasgwillgbegdiscussedgingmuchgmoregdetailglatergingthegbook.gIngthisgoverviewgsec
tion,gwegwillgcovergthegnutsgandgboltsgofgthegbusiness,gprovidinggangoverviewgofgthegstockgandgbondgmarkets,g
andghowgangI-bankgoperatesgwithingthem.
Chapterg2:gCommercialgBanking,gInvestmentgBanking,gandgAssetgManagement
Commercialgbankinggvs.ginvestmentgbanking
<gPAGEg1gOFg1>
Beforegdescribingghowganginvestmentgbankgoperates,glet'sgbackgupgandgstartgbygdescribinggtraditionalgcommer
cialgbanking.gCommercialgandginvestmentgbankinggsharegmanygaspects,gbutgalsoghavegmanygfundamentalgdiff
erences.gAftergagquickgoverviewgofgcommercialgbanking,gwegwillgbuildgupgtogagfullgdiscussiongofgwhatgI-
bankinggentails.
Althoughgthegbarriersgbetweenginvestmentgandgcommercialgbanksghavegessentiallygbeengremovedgbygthegrec
entgpassagegofgthegGramm-Leach-
BlileygFinancialgServicesgModernizationgActgofg1999,gwegwillgforgnowgexaminegthegtraditionalgmodelgofgthegco
mmercialgbankinggindustrygandgcomparegitgtoginvestmentgbanking.gWegwillgthenginvestigateghowgthegnewglegisla
tiongaffectsgcommercialgandginvestmentgbankinggorganizations.gAlso,gwegwillgdistinguishgbetweengthegbuy-
sidegandgthegsell-sidegofgthegsecuritiesgindustry.
3
, Commercialgbankinggvs.ginvestmentgbanking
Whilegregulationghasgchangedgthegbusinessesgingwhichgcommercialgandginvestmentgbanksgmaygnowgparticipa
te,gthegcoregaspectsgofgthesegdifferentgbusinessesgremaingintact.gIngothergwords,gthegdifferencegbetweenghowg
agtypicalginvestmentgbankgandgagtypicalgcommercialgoperategbankgisgsimple:gAgcommercialgbankgtakesgdeposits
gforgcheckinggandgsavingsgaccountsgfrom gconsumersgwhileganginvestmentgbank gdoesgnot.gWe'llg begingexamini
nggwhatgthisgmeansgbygtakinggaglookgatgwhatgcommercialgbanksgdo.
Commercialgbanks
Agcommercialgbankgmayglegallygtakegdepositsgforgcheckinggandgsavingsgaccountsgfromgconsumers.gThegfeder
alggovernmentgprovidesginsurancegguaranteesgongthesegdepositsgthroughgthegFederalgDepositgInsurancegCorp
orationg(thegFDIC),gongamountsgupgtog$100,000.gToggetgFDICgguarantees,gcommercialgbanksgmustgfollowgagmy
riadgofgregulations.
Thegtypicalgcommercialgbankinggprocessgisgfairlygstraightforward.gYougdepositgmoneygintogyourgbank,gandgthe
gbank gloansgthatgmoneygtogconsumersgandgcompaniesgingneedgofgcapitalg(cash).gYougborrowgtogbuygaghouse,g
financegagcar,gorgfinancegangadditiongtogyourghome.gCompaniesgborrowgtogfinancegtheggrowthgofgtheirgcompanyg
orgmeetgimmediategcashgneeds.gCompaniesgthatgborrowgfromgcommercialgbanksgcangrangegingsizegfromgthegd
rygcleanergongthegcornergtogagmultinationalgconglomerate.
Privategcontracts
Importantly,gloansgfromgcommercialgbanksgaregstructuredgasgprivateglegallygbindinggcontractsgbetweengtwogpa
rtiesg-
gthegbank gandg youg(orgthegbank gandgagcompany). gBanksgwork gwithgtheirgclientsgtogindividuallygdeterminegthegt
ermsgofgthegloans,gincludinggthegtimegtogmaturitygandgtheginterestgrategcharged.gYourgindividualgcreditghistoryg(
orgcreditgriskgprofile)gdeterminesgthegamountgyougcangborrowgandghowgmuchginterestgyougaregcharged.gPerha
psgyougneedgtogborrowg$200,000goverg15gyearsgtogfinancegthegpurchasegofgyourghome,gorgmaybegyougneedg$
30,000govergfivegyearsgtogfinancegthegpurchasegofgagcar.gMaybegforgthegfirstgloan,gyougandgthegbankgwillgagreeg
thatgyougpayganginterestgrategofg7.5gpercent;gperhapsgforgthegcargloan,gtheginterestgrategwillgbeg11gpercent.gTheg
samegprocessgappliesgtogloansgtogcompaniesgasgwellg-
gthegratesgaregdeterminedgthroughgag negotiationgbetweengthegbankgandgthegcompany.
Let'sgtakegagminutegtogunderstandghowgagbankgmakesgitsgmoney.gOngmostgloans,gcommercialgbanksgingthe
U.S.gearnginterestganywheregfromg5gtog14gpercent.gAskgyourselfghowgmuchgyourgbankgpaysgyougongyourgdepo
sitsg-
gthegmoneygthatgitgusesgtogmakegloans.gYougprobablygearngagpaltryg1gpercentgongagcheckinggaccount,g ifganything
,gandgmaybeg2gtog3gpercentgongagsavingsgaccount.gCommercialgbanksgthusgmakeggobsgofgmoney,gtakinggadva
ntagegofgtheglargegspreadgbetweengtheirgcostgofgfundsg(1gpercent,gforgexample)gandgtheirgreturngongfundsgloane
dg(ranginggfromg5gtog14gpercent).
Investmentgbanks
Anginvestmentgbankgoperatesgdifferently.gAnginvestmentgbankgdoesgnotghaveganginventorygofgcashgdepositsgtogl
endgasgagcommercialgbankgdoes.gIngessence,ganginvestmentgbankgactsgasgangintermediary,gandgmatchesgsell
ersgofgstocksgandgbondsgwithgbuyersgofgstocksgandgbonds.
Note,ghowever,gthatgcompaniesguseginvestmentgbanksgtowardgthegsamegendgasgtheygusegcommercialgbanks.gIfg
agcompanygneedsgcapital,gitgmayggetgagloangfromgagbank,gorgitgmaygaskganginvestmentgbankgtogsellgequitygorgd
ebtg(stocksgorgbonds).gBecausegcommercialgbanksgalreadyghavegfundsgavailablegfromgtheirgdepositorsgandgan
ginvestmentgbank gdoesgnot,gangI-
bankgmustgspendgconsiderablegtimegfindingginvestorsgingordergtogobtaingcapitalgforgitsgclient.
Publicgsecurities
Investmentgbanksgtypicallygsellgpublicgsecuritiesg(asgopposedgprivategloangagreements).gTechnically,gsecuritie
sgsuchgasgMicrosoftgstockgorgFordgAAAgbonds,grepresentggovernment-
approvedgstocksgorgbondsgthatgaregtradedgeithergongagpublicgexchangegorgthroughgangapprovedgdealer.gThegde
alergisgtheginvestmentgbank.
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