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  • 1. Chapter Sixteen Securities Firms and Investment Banks
  • 2. Services Offered by Securities Firms versus Investment Banks
    • Investment Banks
      • Service entities who wish to raise funds through sales of debt and equity securities, including corporations or governments; services include originating, underwriting, and placing securities in money and capital markets
    • Securities Firms
      • services involve assistance in the trading of securities in the secondary markets (brokerage services or market making)
    • The largest companies in the industry perform multiple services (e.g., underwriting and brokerage) and are generally called investment banks
      • advise corporations on mergers and acquisitions as well as advising on the restructuring of existing corporations
  • 3. Size, Structure, and Composition of the Industry
    • Size of the industry is measured by the equity capital of the firms in the industry ($144.5 bn. in 2001)
    • Three major types of firms
      • national full-line investment banks that service retail and corporate customers (e.g., Merrill Lynch)
      • national full-line firms that specialize in corporate finance (e.g., Goldman Sachs)
      • the remainder of the industry and includes five subclasses
        • specialized investment bank subsidiaries of commercial banks
        • specialized discount brokers
        • regional securities firms
        • specialized electronic trading securities firms
        • venture capital firms
  • 4. Securities Firm and Investment Bank Activity Areas
    • Securities firms and investment banks engage in as many as seven key activity areas
      • Investing
      • Investment Banking
      • Market Making
      • Trading
      • Cash Management
      • Mergers and Acquisitions
      • Other Service Functions
  • 5. Investing
    • Involves managing pools of assets such as mutual funds
    • Compete with commercial banks, life insurance companies, and pension funds
    • Manage funds either as agents for other investors or as principals
    • Objective is to select asset portfolios to beat some return-risk performance benchmark such as the S&P 500
  • 6. Investment Banking
    • Refers to activities related to underwriting and distributing new issues of debt and equity securities
    • Industry is dominated by a small number of underwriting firms
    • Securities underwriting can be undertaken through either public or private offerings
      • Private placement - securities issue placed with one of a few large institutional investors
      • Public placement - may be underwritten on a best efforts or firm commitment basis and offered to the public
  • 7. Market Making
    • Involves the creation of a secondary market in an asset by a securities firm or investment bank
    • Either agency or principal transactions
      • Agency transactions - two-way transactions on behalf of customers
      • Principal transactions - the market maker seeks to profit on the price movements of securities and takes long or short inventory positions for its own account
  • 8. Trading
    • Closely related to market-making activities
    • Six types of trading
      • Position trading - purchases of large blocks on expectation of favorable price move
      • Pure Arbitrage - buying an asset in one market and selling it immediately in another market at a higher price
      • Risk Arbitrage - buying securities in anticipation of some information release
      • Program Trading - simultaneous buying and selling using a computer program to initiate such trades
      • Stock Brokerage - trading securities on behalf of individuals
      • Electronic Brokerage - offered by major brokers, direct access via internet to trading floor
  • 9. Cash Management
    • Securities firms and investment banks offer bank deposit-like cash management accounts (CMAs) to individual investors
      • money market mutual fund sold by investment banks that offer check-writing privileges
  • 10. Mergers and Acquisitions
    • Frequently provide advice on, and assistance in, mergers and acquisitions
      • assist in finding merger partners
      • underwrite any new securities
      • asses the value of target firms
      • recommend terms of the merger agreement
      • assist target firms in preventing a merger
  • 11. Other Service Functions
    • Custody and escrow services
    • Clearance and settlement services
    • Research and advisory services
  • 12. Balance Sheet Assets Assets Cash $ 50,982.3 1.51% Receivable from other broker-dealers 1,204,448.8 35.72 Receivable from customers 177,945.9 5.28 Receivables from noncustomers 15,757.7 0.47 Long positions in securities/commodities 838,254.9 24.86 Securities and investments not marketed 10,550.0 0.31 Securities purchased w/resell agreement 856,043.4 25.39 Exchange membership 1,034.2 0.03 Other assets 216, ,624.5 6.43 Total assets $3,371,641.7 100.00
  • 13. Balance Sheet Liabilities Liabilities Bank loans payable $ 76,191.9 2.26% Payables to other broker-dealers 629,858.6 18.68 Payables to noncustomers 59,910.5 1.78 Payables to customers 391,543.1 11.61 Short positions in securities/commodities 409,342.3 12.14 Securities sold w/repurchase agreements 1,282,870.8 38.05 Other nonsubordinated liabilities 302,757.3 9.16 Subordinated liabilities 68,710.4 2.04 Total liabilities $3,227,184.9 95.72 Capital Equity capital 144,456.7 4.28 Number of firms 7,029
  • 14. Regulation
    • The primary regulator of the securities industry is the Securities and Exchange Commission (SEC) established in 1934
    • SEC sets rules governing securities firms’ underwriting and trading activities
    • Shelf registration – allows qualifying firms that plan to offer multiple issues of stock over two years to submit one registration statement summarizing the firm’s financing plans for the period
    • The Securities Investor Protection Corporation (SIPC) protects investors against losses of up to $500,000 on securities firm failures

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