Chapter Sixteen
Securities Firms and
Investment Banks
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Services Offered by Securities Firms
versus Investment Banks
• Investment Banks
– Service entities who wish to raise funds through sales of debt
and equity securities, including corporations or governments;
services include originating, underwriting, and placing
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
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Size, Structure, and Composition of the
Industry
• Size of the industry is measured by the equity capital of
the firms in the industry ($144.5 bn. in 2001)
• 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 and includes five subclasses
•
•
•
•
•
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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
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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
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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 - 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
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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 - 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
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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 securities on behalf of individuals
– Electronic Brokerage - offered by major brokers, direct access
via internet to trading floor
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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
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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
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Other Service Functions
• Custody and escrow services
• Clearance and settlement services
• Research and advisory services
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Balance Sheet Assets
Assets
Cash
$ 50,982.3
Receivable from other broker-dealers
1,204,448.8
Receivable from customers
177,945.9
Receivables from noncustomers
15,757.7
Long positions in securities/commodities
838,254.9
Securities and investments not marketed
10,550.0
Securities purchased w/resell agreement
856,043.4
Exchange membership
1,034.2
Other assets
216,,624.5
Total assets
$3,371,641.7
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1.51%
35.72
5.28
0.47
24.86
0.31
25.39
0.03
6.43
100.00
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Balance Sheet Liabilities
Liabilities
Bank loans payable
$ 76,191.9
Payables to other broker-dealers
629,858.6
Payables to noncustomers
59,910.5
Payables to customers
391,543.1
Short positions in securities/commodities 409,342.3
Securities sold w/repurchase agreements 1,282,870.8
Other nonsubordinated liabilities
302,757.3
Subordinated liabilities
68,710.4
Total liabilities
$3,227,184.9
2.26%
18.68
1.78
11.61
12.14
38.05
9.16
2.04
95.72
Capital
Equity capital
Number of firms
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144,456.7
7,029
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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 qualifying firms that plan to
offer multiple issues of stock over two years 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
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