Chapter 7 Brokers

8/12/2019 Chapter 7 Brokers

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Chapter 7

Brokers


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What brokers do

Brokers arrange trades for their clients

Search for traders who are willing to trade

Represent their clients at exchanges

Arrange dealers to fill clients orders

Introduce their clients to electronic trading

systems Match clients buy and sell orders


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Types of markets

Order flow markets (NYSE and NASDAQ)

Brokers match clients buy and sell orders

Block markets Brokers search for traders who will take clients

order

Offering markets (IPO and SEO) Brokers sell securities on behalf of issuers

Mergers and acquisition

Brokers find one or both parties


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Why brokers?

Brokers can solve clearing and settlement

problems at low costs

Brokers can access exchanges and dealersthat their clients cannot access

Brokers know who are willing to trade

Brokers are better negotiators

Brokers can represent clients orders when

they cannot represent them themselves


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Structure of a brokerage firm

Front office operations

All activities that involve client contact

Back office operations

All activities that support the front office

operations

Proprietary operations Cash and risk management activities and any

speculative trading that the firm conducts for its

own accounts


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Front office operations

Sales and trading department Sales brokers interact with clients

Floor brokers arrange trades at exchanges

Corporate finance department Investment banking operations

Research department (Use supplements) Analysts provide services to various

departments

Customer service department

Help their clients manage their accounts


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Back office operations

Maintaining accounts

Clearing and settling trades

Providing the information systems that the

firm uses to transmit market data, quotes,

orders, etc

Ensuring that the firm extends credit only to

good credit risks

Ensuring compliance with regulations


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Proprietary operations

All trading activities that the firm conducts

for its house account

For pure brokers, these include cashmanagement and the borrowing and

lending of securities

Include principal trading as a dealer,speculator, or arbitrager


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Broker profitability

Revenues

Commissions (deregulated in1975):Table 7-2

Soft commissions

Payment for order flow

Interest

Underwriting fees (7%) Mergers and acquisition fees

Costslabor costs and interest payments


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Soft Commissions

To obtain order flow under fixed

commissions before deregulation (May

1975) To reduce expense ratios by minimizing

hard dollar expenses after deregulation

(because commissions are not treated asexpenses)


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Principal-agent problem

Performance measurement (Chapter 22) Public disclosure (SEC Rules 11Ac1-5 and

11Ac 1-6) Best executionNBBOs and others

Dual trading problem

Internalized orders (Chapter 25) Front running (Chapter 11)

Order preferencing (Chapter 25) Payment for order flow


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More on dual trading problem

Dual traders trade both as dealers and as brokers(known as broker-dealers)

They fill client ordersthemselves for internalized

orders For client buy (sell) orders, they want sell (buy) at high

(low) pricesConflict of interest!!

They compete with clients when they want to

trade on the same side of the market They want to trade first to get better price and also tobenefit from the market impact of the others trades

Front running

Some markets prohibit all dual trading


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Dishonest brokers

Front running

Inappropriate order exposure

Fraudulent trade assignment Prearranged trading and kickback

schemes

Unauthorized trading and churning Securities theft

Chapter 7 Brokers

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Transcript of Chapter 7 Brokers