6. INVESTMENT BANKING. Invest ment banking is the system by Which invest ment capital is made available, (1) for the uses of industrial enterprise; (2) for civil loans, i.e., loans to municipalities, states and countries. An enterprise is in need of capital, or a state or county, for instance, needs money for the construction of roads or public buildings. It is the function of the investment banker to stand between his clients who have money to lend and the corporation or municipality which wants to borrow, and to see that the needed capital is provided.
The whole system of investment banking as constituted to-day presupposes the ability on the part of those engaged in it to draw capital from their clients for whatever purpose re quired. The X Y Z Railroad, we . will say, which operates a system of electric lines, de cides to spend a nullion dollars on certain im provements which, it feels, will greatly increase its revenue. The road not having that much free cash on hand appeals to some investment banking house for the money, offenng to pay for it such-and-such a rate of interest and, as security, to give to the lenders a mortgage on the property to be acquired. This proposition having been made, the investment banlcer pro ceeds to make an independent examination, and, his engineers having satisfied themselves as to the safety and productivity of the loan, in forms the railroad that he stands ready to ad vance the capital required — in other words, that he will purchase from them at a certain price such-and-such an amount of bonds or stock issued under such-and-such conditions. It is not, of course, his own money which the investment banker figures on advancing. Familiarity with the markets, the price of cap ital and the standing of the concern which. wants to borrow enables him to estimate at just about what price he will be able to dis pose of the securities to be issued. For a cer tain type of stocic or bond issued by a certain type of borrower, he lcnows his clientage will be willing to pay just about such-and-such a price. He figures, for instance, that, counting
all costs of retaihng, he will be able to parcel out a million dollars' worth of high grade bonds at a net price to him of 98. A price somewhere between 90 and 95 would, therefore, be about what he would offer the railroad for the bonds. The difference between what he paid for the bonds and what he got for them by distribut ing them among his clients would constitute his net profit on the transaction.
In theory, a corporation wanting to borrow money by selling new securities advertises in the investment market for bids and sells the securities to the highest bidder. In practice, nearly every large railroad or industnal con cern has its own bankers to whom' the business is invariably given. For this there is good reason. The investment house which is going to interest its clients largely in the securities of a corporation assumes a certain moral obli gation. To be safe, in other words, the banker has got to be close to the property he is financ ing and to remain close to it and in close touch with its affairs. He cannot, therefore, spread his efforts in too many directions. Gradually, in consequence, each investment banking house gathers around itself a certain number of en terprises with whose affairs it is particularly familiar and whose securities it becomes par ticularly fitted to handle.
The methods by which the investment bank ing house, having purchased and paid for a block of new securities, proceeds to distribute these secunties and thus reimburse itself, vary according to the nature and size of the issue. If the issue is a very large one, the chances are that the bonds will be resold not to the individual investment public direct, but rather to a syndicate of smaller investment houses, by whom the final distribution will be effected. If, on the other hand, the issue is a moderate one in size, the chances are.against its passing through any other bankers' hands. The house purchasing the bonds in that case is far more likely to offer the bonds direct to its own clients.