Please help to get answers>Section 3.2. Finance Career Opportunities: Commercial Banks
A commercial bank is the type of bank with which most of us are familiar. A commercial bank takes money deposits from individuals such as us - we are motivated to make such deposits as the bank keeps our money safe. Hence a commercial bank borrows our money. Yet it pays very little interest - either zero interest or close to it. The commercial bank then turns around and lends the money it has borrowed for much higher rates of interest. Hence the commercial bank's the difference between the interest rate it receives when it lends money out and the rate of interest it pays on deposits. This difference is known as the "spread."
For example, consider a commercial bank that has received $100 million of deposits, for which it pays, on average, a 1.00% interest rate per year. The commercial bank lends out the $100 million at an average interest rate of 6% per. The bank generates $5 million of spread, as follows:
Interest paid to borrow: 1% x $100 million:$1 million
Interest received from lending: 6% x $100 million:$6 million
Spread = $6 million - $1 million:$5 million
The difference between the interest rate a commercial bank receives when it lends money out and the rate of interest it pays on deposits is known as the transfer 7" spread 7" invoice gilt Section 3.3. Finance Career Opportunities: Investment Banks Unlike a commercial bank, an investment bank's business model is not to generate spread through taking deposits and lending. Instead, an investment bank generates revenue through acting as a financial intermediary. A financial intermediary intermediates between those that require cash and those that wish to invest. Here are some examples: - A corporation requires funding to build a factory. It requires investors. Investors are looking to invest in the corporation. . An investor holds a large position of bonds. She wishes to sell these bonds. An investor is interested in purchasing the bonds. - An individual is saving for retirement. He wishes to invest in a mutual fund. A mutual fund is looking for investors. In all of the above examples, a financial intermediary is required to intermediate between the entity that require cash and the entity that is looking to invest. An investment bank acts as such a financial intermediary. An investment bank will typically have several divisions, each of which provides different financial intermediation services. Broadly, these divisions are as follows: - Corporate finance . Markets - Investment management - Wealth management Let's briefly explore each of the above. Corporate finance: The corporate finance division of an investment bank focuses on primary market activities. Recall that the "primary market" is the market through which an entity that requires funding can receive funding. A corporate finance division of an investment bank typically provides two types of services: underwriting and advisory. Here's a description of each: - Underwriting: Underwriting is the facilitation of the initial issuance of securities. For example, if a corporation wishes to issue $2 billion of shares, they will approach the corporate finance division of an investment bank. The employees of the bank will work with the corporation to structure the issuance, satisfy regulatory requirements, and identify investors. . Advisory: Advisory is the provision of advice to organizations. For example, a corporation wishes to merge with another corporation. The corporation will approach the corporate finance division of an investment bank. The employees of the bank will work with the corporation to successfully implement the merger. Note that many investment banks refer to their corporate finance division as "investment banking" or "IE" rather than "corporate finance". Markets: The markets division of an investment bank focuses on secondary market sell-side activities. Recall that a secondary market refers to a market through which those that hold investments can sell their investments to other investors. Recall as well that sell-side activities refer to services that are provided to those that manage money (the buy-side). A markets division of an investment bank typically provides four types of services: sales, trading, research, and structuring. Here's a description of each: - Sales: The sales function solicits and services clients for the market division. For example, a sales role may involve reaching out to clients of the bank to make them aware of investment opportunities, and then helping the clients prepare trading orders. - Trading: The trading function executes trades. For example, working with a sales representative, a client may place an order with a bank to purchase 5,000 shares of Proctor and Gamble. The sales representative will direct the order to a trader, which will execute the trade through, for example, sending it to the New York Stock Exchange. . Research: The research function studies securities and writes reports indicating whether the value of the security will change and, if so, by how much. For example, an employee of a bank may be an equity analyst, whose job is to form "buy", "sell", or "hold" recommendations in relation to a given stock over the short-term and long-term. - Structuring: The structuring function forms new and/or customized investment vehicles for clients. For example, a team within the bank may form "collateralized debt obligations" which are sophisticated debt investments that combine numerous smaller loans. Note that many investment banks refer to their markets division as "sales and trading" rather than "markets". All investment bank divisions engage in only sell - side activities O True O False
