1. Securities Firms and Investment Banks Chapter 4 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin

2. -24-2 Overview  In this segment... Securities Firms and Investment Banks: Activities of securities firms and investment banks Size, structure and composition Balance sheets and recent trends Regulation of securities firms and investment banks Global issues

3. -34-3 Securities Firms &Investment Banks  Nature of business: Underwrite securities. Market making. Advising (example: M&A, restructurings).

4. -44-4 Securities Firms &Investment Banks  Growth in domestic M&A: Less than $200 billion in 1990. $1.83 trillion in 2000 In US: bottomed out at $458 billion in 2002 ($1.2 trillion worldwide) $1.3 trillion 2006 ($2.9 trillion worldwide)

5. -54-5 Mergers and acquisitions 1990-2006

6. -64-6 The Largest M&A Transactions

7. -74-7 Size, Structure and Composition  Dramatic increase in number of firms from 1980 to 1987. Decline of 37% following the 1987 crash, to year 2006.  1987: Salomon Brothers held $3.21 billion in capital.  2006: Merrill Lynch held capital of $35.5 billion.  Many recent inter-industry mergers (i.e., insurance companies and investment banks). Role of Financial Services Modernization Act, 1999

8. -84-8 Types and Relative Sizes of Firms  National full-line firms are largest. Merrill Lynch, Morgan Stanley  National full-line firms specializing in corporate finance are second in size. Goldman Sachs, Salomon Brothers/Smith Barney  Remainder of industry: Specialized investment subsidiaries of BHCs. Discount brokers. Regional securities firms (subdivided into large, medium and small). Specialized electronic trading securities firms

9. -94-9 Top U.S.Underwriters, 2006

10. -104-10 Key Activities  Investing  Investment banking Activities related to underwriting and distributing new issues of debt and equity.  Market making Increasing importance of online trading  Technology risk Decimalization  Trading Position trading, pure arbitrage, risk arbitrage, program trading

11. -114-11 Key Activities (continued)  Cash management  Assisting with M&A  Back-office and service functions.

12. -124-12 Trends  Decline in trading volume and brokerage commissions particularly since crash of 1987, although some recovery since 1992. Record volumes 1995- 2000.  Declines in market values--and commission income 2001-2002  Resurgence in market values and commissions during mid-2000s.

13. -134-13 Trends (continued)  Pretax net income over $9 billion per year 1997-2000  Pretax profits soared to $21.0 billion in 2000 curtailed by economic slowdown and September 11 attacks 2001.  2003 record pre-tax profits of $24.1 billion.  Continuing worries over investor confidence

14. -144-14 Balance Sheet  Key assets: Long positions in securities and commodities. Reverse repurchase agreements.  Key liabilities: Repurchase agreements major source of funds. Securities and commodities sold short. Broker call loans from banks  Capital levels much lower than levels in banks

15. -154-15 Regulation  Primary regulator: SEC Reiterated by National Securities Markets Improvement Act (NSMIA) of 1996. Prior to NSMIA, regulated by SEC and states. Regulate trading activities such as shelf registration

16. -164-16 Regulation  Early 2000s erosion of SEC dominance Increased vigilance by State Attorneys General Spring 2003, $1.4 billion in penalties over investor abuses.  Sarbanes-Oxley Act of 2002 Independent auditing oversight board under SEC Instigated by Enron, Global Crossings, Tyco, WorldCom

17. -174-17 Regulation (continued)  Day-to-day regulation: NYSE, NASD  October 2003 implementation of provisions of Patriot Act to combat money laundering Scrutiny of individual identities and affiliations with terrorists

18. -184-18 Investor Protection & Other Monitoring  Securities Investors Protection Corporation (SIPC). Protection level of $500,000  Federal Reserve also has role in overseeing securities firms and investment banks Vulnerability of the financial system Issue of timely settlement raised by Greenspan

19. -194-19 Web Resources  For details of regulation of securities firms and investment banks, visit: SEC: www.sec.govwww.sec.gov NYSE: www.nyse.comwww.nyse.com NASD: www.nasd.comwww.nasd.com SIPC: www.sipc.orgwww.sipc.org

20. -204-20 Global Issues  Global nature of securities firms Demonstrated by recent mergers such as Deutsche Bank/Bankers Trust Dominance of Royal Bank of Scotland in U.S. mortgage backed securities markets  Growth in securities trading and underwriting is a global event  US accounting standards issues  Depreciation of the dollar against the yen and the euro

21. -214-21 Pertinent Websites Federal Reserve: www.federalreserve.govwww.federalreserve.gov NASD: www.nasd.comwww.nasd.com NYSE: www.nyse.comwww.nyse.com SEC: www.sec.govwww.sec.gov Securities Industry Association: www.sia.comwww.sia.com SIPC: www.sipc.orgwww.sipc.org The Banker: www.thebanker.comwww.thebanker.com Thompson Fin. Securities Data: www.thomson.com www.thomson.com Wall Street Journal www.wsj.comwww.wsj.com