History of Investment Banking

Investment banking is a specific division of banking related to the creation of capital for other companies, governments and other entities. Investment banks underwrite new debt and equity securities for all types of corporations, aid in the sale of securities, and help to facilitate mergers and acquisitions, reorganizations and broker trades for both institutions and private investors.
Some of the earliest investment banking practices began in Europe. During the 12th and 13th centuries, European banks made long-terms loans to various rulers. In the 1300’s, Florence, Italy was a banking hub. King Edward III borrowed vast sums of money from the great banks of Florence to fund his war with France. He could not pay the money back, and the three biggest banks in Florence collapsed. 

During the 18th century, intermediaries bought government-issued debt and then resold it to investors at a profit. This process soon spread to the United States, where investment bankers quickly copied the practice. 

In the early 19th century, the financing of US railroads was dependent upon this investment method, which involved mainly investors overseas as well as wealthy US traders and ship owners. This lead to the grow of investment banking in the U.S. as well as in Europe. 

The investment banking industry is still experiencing many changes today. There have been many crisis’s in American history because of little regulation on banks. The government’s monetary policy and regulation of investment banking continually evolves as a result of these panics. Today,  investment banks in the United States are continuously reviewed and regulated by the Securities and Exchange Commission, or SEC. They are also intermittently regulated and investigated by Congress. This helps keep it safe for everyone so that history does not repeat itself. It will also help to avoid another panic to happen in the U.S. 

Banking Panics in America

Throughout American history  there have been various banking crisis’s. A banking crisis usually refers to a situation in a general “market adjustment” when faith in banking institutions falls, and people start trying to move their money to other places for safe keeping. This is called a “run on the banks.” This article will take you through a few of the banking panics that have happened in U.S. history.

Panic of 1873

The Panic of 1873 began with the failure of a prominent investment firm located in Philadelphia called Jay Cooke and Company. The firm was the principal backer of the Northern Pacific Railroad and had handled most of the government’s wartime loans, using a widespread sales campaign back by advertising to sell bonds to people who had never before owned securities. The company speculated, which means they took a risk to try to make more money. Their speculation failed and the firm went bankrupt, along with several other commercial and investment banks. The stock market closed for 10 days and many businesses were forced to shut down after. 

Panic of 1907

The Panic of 1907 was a six-week stretch of runs on banks in New York City and other American cities in October and early November of 1907.It was triggered by a failed speculation that caused the bankruptcy of two brokerage firms. One of those failed speculations came from F.A. Heinz who tried to manipulate the price of a company’s shares. When his attempt failed, the stock market crashed, causing a panic. This also led to “runs” on banks across the nation. In other words, businesses and individuals all tried to withdraw their money at the same time. This run caused banks to collapse, the stock market to crash, and businesses to fail. This is what created a recession in the start of June in 1907.

Stock Market Crash of 1929

The stock market crash of 1929, also called the Great Crash , was a sharp decline in U.S. stock market values began on Black Tuesday on October 29, 1929. It contributed to the Great Depression of the 1930’s. The Great Depression lasted approximately 10 years and affected both industrialized and non industrialized countries in many parts of the world.

Hedge Fund Strategies

Hedge funds use a variety of different strategies and we can group many of these into certain categories that assist an analyst/investor in determining a manager’s skill and evaluating how a particular strategy might perform under certain macroeconomic conditions. The following are only a few classifications of hedge fund strategies and are a general overview.

Equity Hedge

The equity hedge strategy is commonly referred to as a a long/short equity and it is one of the simplest strategies to understand. In this strategy, hedge fund managers can either purchase stocks that they feel are undervalued or sell short stocks they deem to be overvalued. In most cases, the fund will have positive exposure to the equity markets.

Market Neutral

In this strategy, a hedge fund manager applies the same basic concepts mentioned in the previous paragraph, but seeks to minimize the exposure to the broad market. This can be done in two ways. If there are equal amounts of investment in both long and short positions, the net exposure of the fund would be zero.

There is a second way to achieve market neutrality, and that is to have zero beta exposure. In this case, the fund manager would seek to make investments in both long and short positions so that the beta measure of the overall fund is as low as possible. In either of the market-neutral strategies, the fund manager’s intention is to remove any impact of market movements and rely solely on his or her ability to pick stocks.

Either of these long/short strategies can be used within a region, sector or industry, or can be applied to market-cap-specific stocks, etc. In the world of hedge funds, where everyone is trying to differentiate themselves, you will find that individual strategies have their unique nuances, but all of them use the same basic principles described here.

Global Macro

These are the strategies that have the highest risk/return profiles of any hedge fund strategy. Global macro funds invest in stocks, bonds, currencies, commodities, options, futures, forwards and other forms of derivative securities. They tend to place directional bets on the prices of underlying assets and they are usually highly leveraged. Most of these funds have a global perspective and, because of the diversity of investments and the size of the markets in which they invest, they can grow to be quite large before being challenged by capacity issues.

Convertible Arbitrage

These strategies attempt to exploit mis-pricings in corporate convertible securities, such as convertible bonds, warrants, and convertible preferred stock. Managers in this category buy or sell these securities and then hedge part or all of the associated risks. The simplest example is buying convertible bonds and hedging the equity component of the bonds’ risk by shorting the associated stock. In addition to collecting the coupon on the underlying convertible bond, convertible arbitrage strategies can make money if the expected volatility of the underlying asset increases due the embedded option, or if the price of the underlying asset increases rapidly.