Investment bankers are financial middlemen in security offering process. They purchase securities from companies and governments and resell them to the general public. Thus, investment bankers bring together suppliers and users of long-term funds in a capital market and thereby play a key role in security offering process.
Functions of Investment Bankers
The traditional function of the investment bankers has been to act as middlemen in channeling individual’s savings and funds into the purchase of business securities. But nowadays, they also provide advice and help in the distribution of securities. Thus, investment bankers perform four basic functions as follows:
When underwriting a security issue, an investment banker guarantees the issuer that it will receive a specific amount from the issue. In this process, the investment banker buys the security at a lower price and then sells them at a higher price i.e. offer price to the public. Investment bankers take this risk for a specific amount of underwriting spread or commission. If an investment banker cannot sell securities at a specified price, the underwriter, not the company, suffers the loss. Underwriter’s gain or loss is computed using the following equation.
Gain or loss to underwriter = Gross proceeds – proceed to the company- underwriter’s expenses.
Gross proceeds = price to public X number of shares to be issued.
Once the investment banker owns new securities. it must get them into the hands of ultimate investors. Hence, the second function of an investment banker is marketing a new issue of securities. The investment banker is a specialist with a staff and organization to distribute securities.
The investment banker, through experience, becomes an expert in the issuance and marketing of new securities. Thus, they perform an advisory function by analyzing the firm’s financial needs and recommending appropriate means of financing.
- Making a Market
In the case of a company going public for the first time, the investment banker may be obliged to maintain a market for the shares after the issue. The investment banker generally agrees to make a market in the stock and to keep it reasonably liquid. In making a market, the underwriter maintains an inventory in the stocks, quotes bid and asked prices, and stands ready to buy and sell it at those prices.