Chapter Sixteen

1. Chapter Sixteen Securities Firms and Investment Banks

2. Services Offered by Securities Firms versus Investment Banks • Investment Banks • raise the debt and equity securities for corporations or governments including the origination, underwriting, and placement of 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 participating in the industry • 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 more in corporate finance (e.g., Goldman Sachs) • the remainder of the industry and includes four classes • specialized investment bank subsidiaries of commercial banks • specialized discount brokers • regional securities firms • specialized electronic trading securities 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 of 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 $ 27,780.4 1.26% Receivable from other broker-dealers 766,399.7 34.72 Receivable from customers 135,723.3 6.15 Receivables from noncustomers 19,296.1 0.87 Long positions in securities/commodities 514,949.9 23.33 Securities and investments not marketed 8,833.8 0.40 Securities purchased w/resell agreement 647,360.8 29.33 Exchange membership 933.0 0.04 Other assets 85,964.03.90 Total assets $2,111,191.2 100.00

13. Balance Sheet Liabilities Liabilities Bank loans payable $ 47,363.2 2.15% Payables to other broker-dealers 361,774.7 16.39 Payables to noncustomers 39,604.9 1.79 Payables to customers 239,797.3 10.86 Short positions in securities/commodities 263,219.8 11.93 Securities sold w/repurchase agreements 933,214.3 42.28 Other nonsubordinated liabilities 170,715.5 7.73 Subordinated liabilities 55,501.52.52 Total liabilities $2,111,191.2 95.65 Capital Equity capital 96,049.8 4.35 Number of firms 7,785

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 firms that plan to offer multiple issues of stock over a two-year period 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