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Chapter Sixteen Securities Firms and Investment Banks

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Services Offered by Securities Firms versus Investment Banks

• Investment Banks– originating, underwriting, and placing securities in

money and capital markets

• Securities Firms– 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

• Investment Banks– originating, underwriting, and placing securities in

money and capital markets

• Securities Firms– 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

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Size, Structure, and Composition of 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 in corporate

finance (e.g., Goldman Sachs) – the remainder of the industry

• specialized investment bank subsidiaries of commercial banks

• specialized discount brokers

• regional securities firms

• specialized electronic trading securities firms

• venture capital firms

• 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

• specialized investment bank subsidiaries of commercial banks

• specialized discount brokers

• regional securities firms

• specialized electronic trading securities firms

• venture capital firms

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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

• 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

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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

• 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

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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

– Public placement

• 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

– Public placement

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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

– Principal transactions

• Involves the creation of a secondary market in an asset by a securities firm or investment bank

• Either agency or principal transactions– Agency transactions

– Principal transactions

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Trading

• Closely related to market-making activities

• Six types of trading– Position trading

– Pure Arbitrage

– Risk Arbitrage

– Program Trading

– Stock Brokerage Electronic Brokerage

• Closely related to market-making activities

• Six types of trading– Position trading

– Pure Arbitrage

– Risk Arbitrage

– Program Trading

– Stock Brokerage Electronic Brokerage

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Cash Management

• cash management accounts (CMAs) – money market mutual fund sold by

investment banks that offer check-writing privileges

• cash management accounts (CMAs) – money market mutual fund sold by

investment banks that offer check-writing privileges

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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

• 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

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Other Service Functions

• Custody and escrow services

• Clearance and settlement services

• Research and advisory services

• Custody and escrow services

• Clearance and settlement services

• Research and advisory services

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Balance Sheet Assets, 2004

Assets

Cash $ 50,744.0 1.28%Receivable from other broker-dealers 1,530,227.0 38.44Receivable from customers 163,159.2 4.10Receivables from noncustomers 18,345.8 0.46Long positions in securities/commodities 1,075,696.7 27.02Securities and investments not marketed 11,753.1 0.30Securities purchased w/resell agreement 967,008.0 24.29Exchange membership 1,086.6 0.03Other assets 162,346.1 4.08Total assets $3,980,375.4 100.00

Assets

Cash $ 50,744.0 1.28%Receivable from other broker-dealers 1,530,227.0 38.44Receivable from customers 163,159.2 4.10Receivables from noncustomers 18,345.8 0.46Long positions in securities/commodities 1,075,696.7 27.02Securities and investments not marketed 11,753.1 0.30Securities purchased w/resell agreement 967,008.0 24.29Exchange membership 1,086.6 0.03Other assets 162,346.1 4.08Total assets $3,980,375.4 100.00

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Balance Sheet Liabilities, 2004

LiabilitiesBank loans payable $ 75,548.8 1.90%Payables to other broker-dealers 842,983.0 21.18Payables to noncustomers 66,995.6 1.68Payables to customers 407,432.6 10.23Short positions in securities/commodities 510,513.0 12.82Securities sold w/repurchase agreements 1,565,003.7 39.32Other nonsubordinated liabilities 286,459.8 7.20Subordinated liabilities 75,921.7 1.91Total liabilities $3,830,858.1 96.24

CapitalEquity capital 149,517.3 3.76Number of firms 6,549

LiabilitiesBank loans payable $ 75,548.8 1.90%Payables to other broker-dealers 842,983.0 21.18Payables to noncustomers 66,995.6 1.68Payables to customers 407,432.6 10.23Short positions in securities/commodities 510,513.0 12.82Securities sold w/repurchase agreements 1,565,003.7 39.32Other nonsubordinated liabilities 286,459.8 7.20Subordinated liabilities 75,921.7 1.91Total liabilities $3,830,858.1 96.24

CapitalEquity capital 149,517.3 3.76Number of firms 6,549

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Regulation

• The primary regulator of the securities industry is the Securities and Exchange Commission (SEC)

• SEC sets rules governing securities firms’ underwriting and trading activities

• Shelf registration

• The Securities Investor Protection Corporation (SIPC)

• The primary regulator of the securities industry is the Securities and Exchange Commission (SEC)

• SEC sets rules governing securities firms’ underwriting and trading activities

• Shelf registration

• The Securities Investor Protection Corporation (SIPC)