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Securities Operations(25)

Securities Operations(25)






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    Securities Operations(25) Securities Operations(25) Presentation Transcript

    • 25 Securities Operations
    • Chapter Objectives
      • Review and evaluate the key functions of investment banking firms
      • Describe the services provided by investment banking firms when they assist in issuing new stock issues
      • Analyze the risks of securities firms
      • Evaluate the key functions of brokerage firms
      • Evaluate the key factors impacting the value of securities firms
    • Investment Banking Services
      • Investment banking firms (IBFs) assist in raising capital for corporations and state and municipal governments
      • IBF’s serve both financing entities and investors:
        • Serve as an intermediary buying securities (promise to pay) from issuing companies and selling them (securities) to investors
        • Generate fees for services rather than interest income
        • Sell investing services to institutional and other investors
        • Advise companies on mergers and acquisitions
          • Value companies for sale or purchase
          • In recent years, loaned funds for mergers and acquisitions
    • Investment Banking Services Investment Banking Services Origination Underwriting Distribution Advising
    • How IBFs Facilitate New Stock Issues
      • Origination
        • Company wishes to issue additional stock or issue stock for the first time contacts IBF
          • Gets advice on the amount to issue
          • Helps determine stock price for first-time issues
        • IBF assists with SEC filings
          • Registration statement
          • Prospectus—summary of registration statement given to prospective investors
    • How IBFs Facilitate New Stock Issues
      • Underwriting stock
        • Issuer and investment bank negotiate the underwriting spread
          • The difference between the net price given the company and the selling price to investors
          • Incentive to under-price IPO’s
        • The lead investment bank usually forms an underwriting syndicate
          • Other IBFs underwrite a part of the security offering
          • Helps spread the underwriting risk among IBFs
    • How IBFs Facilitate New Stock Issues
      • Distribution of stock
        • Full underwriting vs. best efforts
        • IBFs in the syndicate have retail brokerage operations
        • Other IBF added as part of selling group
        • Corporation incurs flotation costs
          • Underwriting spread
          • Direct issuance costs—accounting, legal fees, etc.
    • How IBFs Facilitate New Stock Issues
      • Advising
        • The IBF acts as an advisor throughout the process
          • Corporations do not have the in-house expertise
          • Includes advice on:
            • Timing
            • Amount
            • Terms
            • Type of financing
    • How IBFs Facilitate New Bond Issues
      • Origination
        • IBF may suggest a maximum amount of bonds that should be issued based on firm characteristics
        • Decisions on coupon rate, maturity
          • Benchmark with market prices of bonds of similar risk
          • Credit rating
        • Bond issuers must register with the SEC
          • Registration Statement
          • Prospectus
    • How IBFs Facilitate New Bond Issues
      • Underwriting bonds
        • Public utilities often use competitive bids to select an IBF, versus…..
        • Corporations typically select an IBF based on reputation and prior working experience
        • The underwriting spread on bonds is lower than that for stocks
          • Can place large blocks with institutional investors
          • Less market risk
    • How IBFs Facilitate New Bond Issues
      • Distribution of bonds
        • Prospectus
        • Advertisements to public
        • Flotation costs are typically in the range of 0.5 percent to 3 percent of face value
    • How IBFs Facilitate New Bond Issues
      • Private placement of bonds
        • Avoids underwriting and SEC registration expenses
        • Potential purchaser may buy the entire issue
          • Insurance companies
          • mutual funds
          • commercial banks
          • pension funds
        • Demand may not be as strong, so price may be less, resulting in a higher cost for issuing firm
        • Investment banks may be involved to provide advice and find potential purchasers
    • How IBFs Facilitate Leveraged Buyouts
      • IBFs facilitate LBOs in three ways:
        • They assess the market value of the LBO firm
        • They arrange financing
        • Purchase outstanding stock held by public
        • Often invest in the deal themselves
        • Provide advice
    • How IBFs Facilitate Arbitrage
      • Arbitrage = purchasing of undervalued shares and reselling the shares at a higher price
      • IBFs work with arbitrage firms to search for undervalued firms
      • Asset stripping
        • A firm is acquired, and then its individual divisions are sold off
        • Sum of the parts is greater than the whole
          • Kohlberg, Kravis, and Roberts
    • How IBFs Facilitate Arbitrage
      • IBFs generate fee income from advising arbitrage firms as well as a commission on the bonds issued to support arbitrage activity
      • IBFs also provide bridge loans
        • When fund raising is not expected to be complete when the acquisition is initiated
      • IBFs provide advice on takeover defense maneuvers
    • How IBFs Facilitate Arbitrage
      • History of arbitrage activity
        • Greenmail is when a target company buys back stock from arbitrage firm at a premium over market price
        • Arbitrage activity has been criticized
          • Results in excessive financial leverage and risk for corporations
          • Restructuring sometimes results in layoffs
        • Arbitrage helps remove managerial inefficiencies
        • Target shareholders can benefit from higher share prices
    • Brokerage Services
      • Full-service versus discount brokerage services
        • Full-service firms provide investment advice as well as executing transactions
        • Discount brokerage firms only execute security transactions upon request
        • Online brokerage firms
    • Allocation of Revenue Sources
      • Importance of brokerage commissions has declined in recent years
      • Largest source of revenue has been trading and investment profits
      • Underwriting and margin interest also make up a significant portion of revenue
      • Revenue from fees earned on advising and executing acquisitions has increased over time
    • Regulation of Securities Firms
      • Regulated by the National Association of Securities Dealers (NASD) and securities exchanges
      • The SEC regulates the issuance of securities and specifies disclosure rules for issuers
        • Also regulates exchanges and brokerage firms
      • SEC establishes general guidelines, while the NASD provides day-to-day self-regulatory duties
    • Regulation of Securities Firms
      • The Federal Reserve determines the credit limits (margin requirements) on securities purchased
      • The Securities Investor Protection Corporation (SIPC) offers insurance on brokerage accounts
        • Insured up to $500,000
        • Brokers pay premiums to SIPC to maintain the fund
        • Boosts investor confidence, increasing economic efficiency
    • Regulation of Securities Firms
      • Financial Services Modernization Act of 1999
        • Permitted banking, securities activities, and insurance to be offered by a single firm
        • Varied financial services organized as subsidiaries under special holding company
        • Financial holding companies regulated by the Federal Reserve
    • Risks of Securities Firms Exchange Rate Risk Market Risk Interest Rate Risk Credit Risk
    • Risks of Securities Firms
      • Market risk
        • Securities firms’ activities are linked to stock market conditions
        • When stock prices are rising:
          • Greater volume of stock offerings
          • Increased secondary market transactions
          • More mutual fund activity
          • Securities firms take equity positions which are bolstered when prices rise
    • Risks of Securities Firms
      • Interest rate risk
        • Performance of securities firms can be sensitive to interest rate movements because:
          • Market values of bonds held as investments increase as interest rates fall
          • Lower rates can encourage investors to withdraw money from banks and invest in stocks
      • Exchange rate risk
        • Operations in foreign countries
        • Investments in securities denominated in foreign currency
    • Valuation of Securities Firms
      • Value of a securities firm depends on its expected cash flows and required rate of return
       V = f [  E(CF),  k]  V = Change in value of the securities firm  k = Change in required rate or return Where:  E(CF) = Change in expected cash flows +
    • Valuation of Securities Firms
      • Factors that affect cash flows
      E(CF) = Expected cash flow R f = Risk free interest rate INDUS = Prevailing industry conditions Where:  E(CF)= f (  ECON,  R f ,  INDUS,  MANAB) ECON = Economic growth MANAB = The ability of the security firm’s management + + ?
    • Valuation of Securities Firms
      • Investors required rate of return
       k = f (  R f ,  RP) + + R f = Risk free interest rate Where: RP = Risk premium
    • Interaction With Other Financial Institutions
      • Offer investment advice and execute security transactions for financial institutions that maintain security portfolios
      • Compete against financial institutions that have brokerage subsidiaries
      • Glass-Steagall Act of 1933 separated the functions of commercial banks and investment banking firms
      • Financial Services Modernization Act of 1999
        • Effectively repealed Glass-Steagall
        • Commercial banks, securities firms, and insurance companies will increasingly offer similar services
    • Globalization of Securities Firms
      • Securities firms have increased their presence in foreign countries
        • Merrill Lynch has more than 500 offices spread across the world
          • Allows them to place securities in various markets for corporations or governments
          • International M&A
          • Ability to handle transactions with foreign securities
    • Globalization of Securities Firms
      • Growth in international securities transactions
        • Created more business for large securities firms
          • International stock offerings
          • Increased liquidity for issuing firm, avoiding downward price pressure
        • Growth in Latin America
          • Increased business due to NAFTA
        • Growth in Japan
          • Some barriers to foreign securities firms still exist