What does an investment bank actually do?
Advises companies on major transactions such as M&A and helps them raise capital through equity and debt offerings. The bank earns fees for advice, underwriting, execution, and distribution.
Intuition
An investment bank exists because capital markets are fragmented: issuers need funding or strategic advice, investors need access and liquidity, and someone has to intermediate risk. The bank bridges that gap by converting uncertainty into transactable confidence — packaging information, pricing, and distribution so capital moves from those who have it to those who can use it.
Watch
Expect a follow-up on the revenue mix or which division is largest — S&T typically generates the most revenue (~40–50%) at a bulge bracket, not IBD.
Deep Dive
Explain the core functions of an investment bank and how they generate revenue, beyond the textbook definition.
Three Core Businesses:
| Division | What It Does | How It Makes Money |
|---|---|---|
| IBD | Advises on M&A, raises debt and equity capital | Advisory fees (0.5%–2% of deal value for M&A), underwriting fees (~3%–7% on IPOs) |
| Sales & Trading | Makes markets in equities, FI, derivatives; executes client trades | Bid-ask spread, commissions, principal gains on inventory |
| Asset/Wealth Mgmt | Manages money for institutions and HNW individuals | Management fees (~0.5%–1.5% of AUM), performance fees |
IBD Sub-groups:
- M&A / Advisory — Sell-side, buy-side, restructuring. Fee earned at close.
- Capital Markets — ECM (IPOs, follow-ons, convertibles) and DCM (IG bonds, HY bonds, leveraged loans). Bank underwrites: buys securities from issuer at set price, resells higher. Difference = gross spread.
M&A Deal Flow:
- Pitch (pitch book: valuation, buyers, market)
- Mandate (engagement letter, fees agreed)
- Preparation (model, CIM)
- Marketing (auction or bilateral)
- Diligence & Negotiation (purchase agreement)
- Signing & Closing (regulatory approvals, fee paid)
ECM/IPO Flow:
- Engagement (bookrunners hired)
- S-1 Filing (with lawyers)
- Roadshow (management meets investors)
- Book Building (indications of interest)
- Pricing (issuer gets price minus gross spread)
- Allocation & Trading (aftermarket stabilization possible)
IPO Fee Example — $500M IPO at 5% spread:
Spreads: ~7% for small deals, ~3–4% for large deals.
Cross-division linkage: IBD originates → S&T executes the securities clients issue/trade → Asset Mgmt buys for its funds. Fees at every step.
Revenue Mix (bulge bracket, illustrative):
| Source | Share |
|---|---|
| S&T | ~40–50% |
| IBD | ~25–30% |
| Asset/Wealth Mgmt | ~20–30% |
Shortcut: IB = intermediary between those who need capital and those who have it — fees come from advice, underwriting, execution, and distribution.