The Financial World
1.0 What is Investment?
Let’s say you have a business idea, you need X million to make the world’s first car. You know you’re going to make a lot of money but you need some start-up capital. The only thing stopping you is money. There are different ways you could raise capital:
- Stocks
- Bonds
- Derivatives
1.1 Stocks
The most common method of rasing money for a business is to issue "common" stock e.g. If I wanted to raise £10 I could issue 10 shares at £1 on an exchange which could be purchased by anyone. This represents fractional ownership of the company.
1.2 Bonds
Bonds are another method to raise capital, it represents a contract that states that if you pay my £10,000 I will pay you £12,000 over given time period the final payment is given at maturity. Bonds can also pay a coupon at a given interest rate through fixed times in the year.
1.3 Derivatives
Derivatives are contracts which give you the right/obligation to buy stock/bonds if certain conditions are met. The world of derivatives is vast and extremely complex.
2.0 Capital Structure
The proportion of Stocks and Bonds (Equity and Debt) that has been used to finance a company is referred to it's capital structure and its a useful concept to understand.
3.0 Financial Industry
Investment Banking deals with the creation and sale of financial instruments. The world of Asset Management deals with the purchase of these financial instruments. Hence, Investment banking is referred to as the Sell Side and Asset Management referrs to the Buy Side.
3.1 Asset Management
Asset management concerns the buying and selling of financial instruments on behalf of clients with a view that these financial instruments will increase in value. Generally this is the workflow:
The portfolio is essentially a list of financial instruments which are to be bought and sold. If the fund has access to the markets where these instruments are bought/sold they will make these transactions themselves. Otherwise these transactions will have to be done through a broker/Investment Bank. There are also other "Asset Managers" which include Private Equity and Venture Capital which take stakes in companies and have a hand in their growth.
3.2 Investment Banking
The creation/modification of a companies capital structure happens Investment Banking Division (IBD) department of a bank, the selling of these stocks occurs on the Trading department generally referred to as Markets. These are the two key departments in an investment bank.
In terms of workflow the trading department would receive trade orders from Asset Managers to buy/sell financial instruments on their behalf:
3.3 Private Equity
This is a form of Asset Managment but there are some key differences, the world of private equity involves identifying a companies, providing investment/re-structuring to help grow the company and then re-sell their ownership of that company at a later date when it has increased in value. The type of company that a private equity firm aims to target depends on the firm. The key difference here is the fact that the ownership of the company that the private equity firm purchases are not available to the general public. Investment by a private equity firm implies more than simply buying shares it implies that there is an active effort to improve the company.
4.0 Real World
This is a general overview, having worked in both industries the inner workings are orders of magnitude more complicated. But as an overview this should suffice. I'll be writing more in depth articles on most of these topics in the future. In terms of personal interest, the asset management side is more interesting in terms of the work that's involved. In my opinion there is more room for analysis and predictive analytics in Asset Management. With Investment Banking being limited to algorithms that promote liquidity (Quantitative Market Making) and "smart" order management systems.