o. What are some other investment banking activities? How did these increase investment banks’ risk?
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Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point that expansion throughout the entire Southeast is feasible. The proposed expansion would require the firm to raise about $18.3 million in new capital. Because Randy’s currently has a debt ratio of 50% and because family members already have all their personal wealth invested in the company, the family would like to sell common stock to the public to raise the $18.3 million. However, the family wants to retain voting control. You have been asked to brief family members on the issues involved by answering the following questions: |
Explanation
Investment banking includes the following activities:
Mergers and acquisitions:
a) Investment banks help finding weak or small firms to be acquired by powerful firms in the industry in return of fixed commission.
b) Investment banks act as the underwriters for performing issues of new share capital by the acquirer firm after the process of merger and acquisition.
c) Investment banks often serve as advisors for both acquirer and acquired firms while dealing with the merger and acquisitions.
Securitization: Investment banks serve as advisors for the firm while converting its financial assets or debts into financial securities.
They also perform the task of securitizer by purchasing assets or debt from various companies, pooling them into attractive portfolios and then selling the portfolios to potential investors.
Asset Management: Investment banks manage the investments of investors in order to expand their portfolio and yield higher returns through investing in valuable securities or withdrawing money from the securities going to incur losses in the coming future on the behalf of the investors.
Trading operations: Investment banks have to perform various trading operations to earn their own profits as well as to work on behalf of the investors.
They analyse the market and purchase securities at low prices, sell them at higher prices as the favourable market condition arises, thereby earning profits.
They help the investors in selling and buying profitable stocks while mitigating risk.
Investment banking activities increases the risk in the following ways:
While providing underwriting services, all the securities of the company may not be subscribed by the investors, so investment banks need to purchase the leftover securities and pay for them as per the agreement.
The investors might not subscribe to the securitized portfolios which the bank has created through purchasing debt and assets from the company.
The bank may incur losses while selling the securities they purchased from the companies due to fall in the market price of securities, rise in interest rate or exchange rate in future.
Verified Answer
Investment banking activities includes:
Mergers and acquisitions: Banks provide assistance to the firms who want to merge their holdings with other firms and also assist them in acquiring other firms.
Securitization: Banks purchase the debt and assets of the companies, convert them into financial instruments and issue them to the investors.
Asset management: Investment banks manage the investments of investors in order to expand their portfolio and yield higher returns
Trading operations: Banks perform the trading operations which includes buying and selling of securities on behalf of the company.
Investment banking activities increases the risk in the following ways:
The risk of selling securities in case of underwritten services by the bank.The underwriter has to bear the cost if securities of the company are undersubscribed by the public.
The risk of selling securitized portfolios.The investment banks purchase the debt and assets of companies and sell them to the public as financial instruments, the investments of banks in assets and debts of the companies get wasted in case securitized instruments are not applied by the investors.
Risk of bearing loss on selling securities due to fall in market price of securities. The investment banks also perform the trading operations that is, buying and selling of securities on behalf of investors.
