Question

Explain in detail the purpose of an investment bank and the differentiation between investment banks and merchant banks..

Answer 1

In general investment banks buy and sell securities to help raise capital for companies. Merchant banks are primarily lending institutions that provide financial services to businesses. More specifically, according to Wikipedia the following definitions apply to Investment Banking and Merchant Banking: “An investment bank is a financial institution that assists individuals, corporations and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities. An investment bank may also assist companies involved in mergers and acquisitions, and provide ancillary services such as market making, trading of derivatives, fixed income instruments, foreign exchange, commodities, and equity securities.
Unlike commercial banks and retail banks, investment banks do not take deposits. A merchant bank is a financial institution which provides capital to companies in the form of share ownership instead of loans. A merchant bank also provides advisory on corporate matters to the firms they lend to.
Today, according to the US Federal Deposit Insurance Corporation (acronym FDIC), "the term merchant banking is generally understood to mean negotiated private equity investment by financial institutions in the unregistered securities of either privately or publicly held companies." Both commercial banks and investment banks may engage in merchant banking activities. Historically, merchant banks' original purpose was to facilitate and/or finance production and trade of commodities, hence the name "merchant". Few banks today restrict their activities to such a narrow scope.”

Answer 2

Investment banks engage in speculation, trying to maximize profits by financial intermediation or investment in short periods of time.
Merchant banks, in theory, engage in productive investments, non speculation and in longer periods of time.