Chapter Sixteen  Securities Firms  and  Investment Banks
Services Offered by Securities Firms versus Investment Banks <ul><li>Investment Banks </li></ul><ul><ul><li>Service entiti...
Size, Structure, and Composition of the Industry <ul><li>Size of the industry is measured by the equity capital of the fir...
Securities Firm and Investment Bank Activity Areas <ul><li>Securities firms and investment banks engage in as many as seve...
Investing <ul><li>Involves managing pools of assets such as mutual funds  </li></ul><ul><li>Compete with commercial banks,...
Investment Banking <ul><li>Refers to activities related to underwriting and distributing new issues of debt and equity sec...
Market Making <ul><li>Involves the creation of a secondary market in an asset by a securities firm or investment bank </li...
Trading <ul><li>Closely related to market-making activities </li></ul><ul><li>Six types of trading </li></ul><ul><ul><li>P...
Cash Management <ul><li>Securities firms and investment banks offer bank deposit-like  cash management accounts   (CMAs)  ...
Mergers and Acquisitions <ul><li>Frequently provide advice on, and assistance in, mergers and acquisitions </li></ul><ul><...
Other Service Functions <ul><li>Custody and escrow services </li></ul><ul><li>Clearance and settlement services </li></ul>...
Balance Sheet Assets Assets Cash  $  50,982.3  1.51% Receivable from other broker-dealers  1,204,448.8  35.72 Receivable f...
Balance Sheet Liabilities Liabilities Bank loans payable  $  76,191.9  2.26% Payables to other broker-dealers  629,858.6  ...
Regulation <ul><li>The primary regulator of the securities industry is the Securities and Exchange Commission (SEC) establ...
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McGraw-Hill /Irwin Copyright © 2004 by The McGraw-Hill ...

  1. 1. Chapter Sixteen Securities Firms and Investment Banks
  2. 2. Services Offered by Securities Firms versus Investment Banks <ul><li>Investment Banks </li></ul><ul><ul><li>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 </li></ul></ul><ul><li>Securities Firms </li></ul><ul><ul><li>services involve assistance in the trading of securities in the secondary markets (brokerage services or market making) </li></ul></ul><ul><li>The largest companies in the industry perform multiple services (e.g., underwriting and brokerage) and are generally called investment banks </li></ul><ul><ul><li>advise corporations on mergers and acquisitions as well as advising on the restructuring of existing corporations </li></ul></ul>
  3. 3. Size, Structure, and Composition of the Industry <ul><li>Size of the industry is measured by the equity capital of the firms in the industry ($144.5 bn. in 2001) </li></ul><ul><li>Three major types of firms </li></ul><ul><ul><li>national full-line investment banks that service retail and corporate customers (e.g., Merrill Lynch) </li></ul></ul><ul><ul><li>national full-line firms that specialize in corporate finance (e.g., Goldman Sachs) </li></ul></ul><ul><ul><li>the remainder of the industry and includes five subclasses </li></ul></ul><ul><ul><ul><li>specialized investment bank subsidiaries of commercial banks </li></ul></ul></ul><ul><ul><ul><li>specialized discount brokers </li></ul></ul></ul><ul><ul><ul><li>regional securities firms </li></ul></ul></ul><ul><ul><ul><li>specialized electronic trading securities firms </li></ul></ul></ul><ul><ul><ul><li>venture capital firms </li></ul></ul></ul>
  4. 4. Securities Firm and Investment Bank Activity Areas <ul><li>Securities firms and investment banks engage in as many as seven key activity areas </li></ul><ul><ul><li>Investing </li></ul></ul><ul><ul><li>Investment Banking </li></ul></ul><ul><ul><li>Market Making </li></ul></ul><ul><ul><li>Trading </li></ul></ul><ul><ul><li>Cash Management </li></ul></ul><ul><ul><li>Mergers and Acquisitions </li></ul></ul><ul><ul><li>Other Service Functions </li></ul></ul>
  5. 5. Investing <ul><li>Involves managing pools of assets such as mutual funds </li></ul><ul><li>Compete with commercial banks, life insurance companies, and pension funds </li></ul><ul><li>Manage funds either as agents for other investors or as principals </li></ul><ul><li>Objective is to select asset portfolios to beat some return-risk performance benchmark such as the S&P 500 </li></ul>
  6. 6. Investment Banking <ul><li>Refers to activities related to underwriting and distributing new issues of debt and equity securities </li></ul><ul><li>Industry is dominated by a small number of underwriting firms </li></ul><ul><li>Securities underwriting can be undertaken through either public or private offerings </li></ul><ul><ul><li>Private placement - securities issue placed with one of a few large institutional investors </li></ul></ul><ul><ul><li>Public placement - may be underwritten on a best efforts or firm commitment basis and offered to the public </li></ul></ul>
  7. 7. Market Making <ul><li>Involves the creation of a secondary market in an asset by a securities firm or investment bank </li></ul><ul><li>Either agency or principal transactions </li></ul><ul><ul><li>Agency transactions - two-way transactions on behalf of customers </li></ul></ul><ul><ul><li>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 </li></ul></ul>
  8. 8. Trading <ul><li>Closely related to market-making activities </li></ul><ul><li>Six types of trading </li></ul><ul><ul><li>Position trading - purchases of large blocks on expectation of favorable price move </li></ul></ul><ul><ul><li>Pure Arbitrage - buying an asset in one market and selling it immediately in another market at a higher price </li></ul></ul><ul><ul><li>Risk Arbitrage - buying securities in anticipation of some information release </li></ul></ul><ul><ul><li>Program Trading - simultaneous buying and selling using a computer program to initiate such trades </li></ul></ul><ul><ul><li>Stock Brokerage - trading securities on behalf of individuals </li></ul></ul><ul><ul><li>Electronic Brokerage - offered by major brokers, direct access via internet to trading floor </li></ul></ul>
  9. 9. Cash Management <ul><li>Securities firms and investment banks offer bank deposit-like cash management accounts (CMAs) to individual investors </li></ul><ul><ul><li>money market mutual fund sold by investment banks that offer check-writing privileges </li></ul></ul>
  10. 10. Mergers and Acquisitions <ul><li>Frequently provide advice on, and assistance in, mergers and acquisitions </li></ul><ul><ul><li>assist in finding merger partners </li></ul></ul><ul><ul><li>underwrite any new securities </li></ul></ul><ul><ul><li>asses the value of target firms </li></ul></ul><ul><ul><li>recommend terms of the merger agreement </li></ul></ul><ul><ul><li>assist target firms in preventing a merger </li></ul></ul>
  11. 11. Other Service Functions <ul><li>Custody and escrow services </li></ul><ul><li>Clearance and settlement services </li></ul><ul><li>Research and advisory services </li></ul>
  12. 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. 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. 14. Regulation <ul><li>The primary regulator of the securities industry is the Securities and Exchange Commission (SEC) established in 1934 </li></ul><ul><li>SEC sets rules governing securities firms’ underwriting and trading activities </li></ul><ul><li>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 </li></ul><ul><li>The Securities Investor Protection Corporation (SIPC) protects investors against losses of up to $500,000 on securities firm failures </li></ul>
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