Chapter Sixteen Securities Firms and Investment Banks Learning Goals LG 16-1 Know the different types of securities firms and investment banks. LG 16-2 Understand the major activity areas in which securities firms and investment banks engage. LG 16-3 Differentiate among the major assets and liabilities held by securities firms. LG 16-4 Know the main regulators of securities firms and investment banks. McGraw-Hill/Irwin

Securities Firms and Investment Banks (IBs) Investment banks (IBs) help corporations and governments raise capital through debt and equity security issues in the primary market underwriting is assisting in the issue of new securities IBs also advise on mergers and acquisitions (M&As) and corporate restructuring Securities firms assist in the trading of securities in secondary markets broker-dealers assist in the trading of existing securities McGraw-Hill/Irwin 16-2 2

Securities Firms and Investment Banks (IBs) Commercial side of business is done by IB which include: originating, underwriting, and distributing issue of new securities Retail side of business is done by Security Firms purchase , sale, and brokerage of existing securities. McGraw-Hill/Irwin 16-3 3

Securities Firms and Investment Banks (IBs) Size, Structure and Composition of the Industry The size of the industry is usually measured by the equity capital of firms rather than total asset size The number of firms in the industry usually follows the overall condition of the economy McGraw-Hill/Irwin 16-4 4

Securities Firms and Investment Banks (IBs) Activity Areas Securities firms and investment banks 8 key activity areas: Investment banking Market making Trading Investing Cash management Mergers and acquisitions Venture capital Other service functions. McGraw-Hill/Irwin 16-5 5

Securities Firms and Investment Banks (IBs) Investment banking first time debt and equity issues occur through initial public offerings (IPOs) new issues from a firm whose debt or equity is already traded are called seasoned equity offerings (SEOs) a private placement is a securities issue that is placed with one or a few large institutional investors public offerings are offered to the public at large IBs act only as an agent in best efforts underwriting IBs act as principals in firm commitments McGraw-Hill/Irwin 16-6 6

Best Efford vs. Firm Committment Securities Offering A) IB agrees to underwrite an issue of 20 million shares for ABC Corporation on a firm commitment base. IB pays $15.50 per share to ABC Corporation for the 20 mio shares of stock. It then selles the shares for $16.35 per share. 1) How much money does ABC Corporation receive? 2) What is the profit to the IB? 3) If the IB can only sell the shares for 14.75, how much money does ABC Corporation receive? 4) What is the Profit of IB? B) IB agrees to underwrite in best efford bases. IB can sell only 18,400 shares for $15.50 per share and per share IB charges ABC Corporation for $0.375 1)How much money can ABC Corporation receive? 2)The profit of IB? 3)What would happen if IB could sell only for 14.75? (ABC Corporation and IB profit) McGraw-Hill/Irwin 16-7 7

Securities Firms and Investment Banks (IBs) Market making involves the creation of secondary markets in an asset by a securities firms or investment banks. In addition of being primary dealers, investment banks make a secondary market for these instruments. agency transactions: two-way transactions on behalf of customers for fee commission principal transactions: market makers seek to profit for their own accounts McGraw-Hill/Irwin 16-8 8

Securities Firms and Investment Banks (IBs) Trading involves the more frequent buying and selling of stock, or other instruments, with the goal of generating returns. Trading profits are generated through buying at a lower price and selling at a higher price within a relatively short period of time. Position Trader – positions are held from months to years Swing Trader – positions are held from days to weeks Day Trader – positions are held throughout the day only with no overnight position McGraw-Hill/Irwin 16-9 9

Securities Firms and Investment Banks (IBs) Types of Trading: Program Trading—is the simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1 million, using computer programs to initiate such trades. computers are used to continuously monitor stock and futures prices—and can even initiate buy or sell orders—these trades are classified separately as program trading. Stock Brokerage—involves the trading of securities on behalf of individuals who want to transact in the money or capital markets. McGraw-Hill/Irwin 16-10 10

Securities Firms and Investment Banks (IBs) Investing involves managing pools of assets such as closed- and open-end mutual funds .Securities firms can manage such funds either as agents for other investors or as principals for themselves and their stockholders. it tends to produce a more stable flow of income than does either investment banking or trading McGraw-Hill/Irwin 16-11 11

Securities Firms and Investment Banks (IBs) Mergers and Acquisitions investment banks frequently provide advice on, and assistance in, mergers and acquisitions. assist in finding merger partners underwrite any new securities to be issued by the merged firms assess the value of target firms recommend terms of the merger agreement McGraw-Hill/Irwin 16-12 12

Securities Firms and Investment Banks (IBs) Venture Capital is a professionally managed pool of money used to finance new and often high-risk firms for an equity investment in the firm A difficulty for new and small firms in obtaining debt financing from commercial banks is that CBs are generally not willing or able to make loans to new companies with no assets and business history investments to get capital financing as well as advice. McGraw-Hill/Irwin 16-13 13

Securities Firms and Investment Banks (IBs) new and small firms often turn to investment banks (and other firms) that make venture capital Venture capital firms do not make outright loans. Rather, they purchase an equity interest in the firm that gives them the same rights and privileges associated with an equity investment made by the firm’s other owners. venture capital firms tend to utilize teams of either scientific or business professionals to help them . Venture capital firms receive many unsolicited proposals of funding from new and small firms. A majority of these requests are rejected. McGraw-Hill/Irwin 16-14 14

Securities Firms and Investment Banks (IBs) Venture capital firms look for two things in making their decisions to invest in a firm. 1. high return. Venture capital firms are willing to invest in high-risk new and small firms. However, they require high levels of returns 2. An easy exit. Venture capital firms realize a profit on their investments by eventually selling their interests in the firm. They want a quick and easy exit opportunity when it comes time to sell. McGraw-Hill/Irwin 16-15 15