Capital acquisition process:

What are the principal functions of an investment bank? Why is it called an 'investment' bank? How does it help in the capital acquisition process of firms? These are questions we explore in this Section. Investment banks perform two main functions for their clients. These are: raising funds for their clients, and helping clients in the sale or purchase of securities. In this Section we discuss the basic functions of investment firms and the basics of underwriting processes. But first we take a look at the main broad functions of investment banks. Some have suggested that invested banking can be defined in terms of the types of function they  perform. Hence four types of definitions of investment banks have been suggested.

According to the broadest definition investment banking includes all functions related to the securities markets as well as other  financial services like real estate and insurance. The next broadest definition considers all types of activities related to capital markets, from underwriting and corporate finance, to mergers and acquisitions to venture capital. In this definition certain other financial functions are excluded that are included as per the first definition. This second definition would exclude activities like real estate, insurance, and mortgage banking. The third definition is narrower than the first two. In this definition, only some activities of capital markets are included. The stress is on underwriting, and on their role in mergers and acquisitions. Venture capital, primary commodities trade etc are excluded. The final definition is the narrowest of the four and is closest to the traditional  historical definition of investment banking. This fourth definition restricts the functions to those of underwriting and acquisition of capital in the primary markets, and brokering and helping in the deals in the secondary market. In this Unit, we primarily restrict ourselves to this final definition.

We will deal with securities markets in the next Unit. Here we discuss the process of underwriting of securities by investment  banks, as that is their main function. An underwriter firm (investment bank)  is a firm that buys an issue from a company and resells it to investors in the primary security market; it is thus a primary market activity.  Underwriters buy the securities to be issued at a reduced (discounted) price. This discount is usually measured as a percent of the price of the issue. A firm that wants to raise capital can do so primarily through debt instruments (borrowings) or by issuing equity shares in the primary market. Most primary issues of securities are sold by the firm to the public through investment bankers. Investment banking firms are broker-dealer firms that provide a number of services, depending on the type of offering. Investment banks offer services both to the  issuing firm and to the investing public. In a usual offering to the public in the primary markets, investment banking firms provide three  services: (1) the advisory or managing function (2) the underwriting, or risk-bearing function and (3) the selling, or  distribution, function.

In an underwriting process that is of the negotiated variety, the managing underwriter is involved with the public offering right from the beginning, that is, from the time that the issuing firm decides to raise new capital. The managing and advisory underwriting investment bank advises the firm that is engaged in the process of capital acquisition as to the types of securities that the primary market would be most receptive to, when to actually carry out the issuing of the securities, and most importantly, how to price the security, that is, the price at which the security ought to be offered. The investment bank also tries to ensure that all legal  requirements connected to the issue are met.