Securities Operations

Securities Operations

Investment Banking Services

n     Investment banking firms (IBFs) assist in raising capital for corporations and state and municipal governments

n     IBF’s serve both financing entities and investors:

l      Serve as an intermediary buying securities (promise to pay) from issuing companies and selling them (securities) to investors

l      Generate fees for services rather than interest income

l      Advise companies on mergers and acquisitions

u   Value companies for sale or purchase

u   Loan funds for mergers and acquisitions

How IBFs Facilitate Stock/Bond Issues

n     Origination

l      Company wishes to issue stock or bond contacts IBF

u   Gets advice on the amount to issue

u   Helps determine stock price for first-time issues

l      Decisions on coupon rate, maturity (for bonds)

l      IBF assists with SEC filings

u   Registration statement

u   Prospectus—summary of registration statement given to prospective investors

How IBFs Facilitate Stock/Bond Issues

n     Underwriting stock

l      Issuer and investment bank negotiate the underwriting spread

u   The difference between the net price given the company and the selling price to investors

u   The underwriting spread on bonds is lower than that for stocks

n   Easier to sell (high liquidity)

n   Less market risk

l      The lead investment bank usually forms an underwriting syndicate

How IBFs Facilitate Stock/Bond Issues

n     Distribution of stocks and bonds

l      Best-efforts agreement: price not guaranteed

l      IBFs in the syndicate have retail brokerage operations

l      Corporation incurs flotation costs

u   Underwriting spread

u   Direct issuance costs—accounting, legal fees, etc.

How IBFs Facilitate Stock/Bond Issues

n     Advising

l      The IBF acts as an advisor throughout the process

u   Corporations do not have the in-house expertise

u   Includes advice on:

n    Timing

n    Amount

n    Terms

n    Type of financing

Private placement of bonds

n     Avoids underwriting and SEC registration expenses

n     Potential purchaser may buy the entire issue

l      Insurance companies

l       mutual funds

l       commercial banks

l       pension funds

n     Demand may not be as strong, so price may be less, resulting in a higher cost for issuing firm

n     Investment banks may be involved to provide advice and find potential purchasers

How IBFs Facilitate Arbitrage

n     Arbitrage = purchasing of undervalued shares and reselling the shares at a higher price

n     IBFs work with arbitrage firms to search for undervalued firms, and provide bridge loans to finance the acquisition

n     Asset stripping

l      A firm is acquired, and then its individual divisions are sold off

l      Assumes that sum of the parts is greater than the whole

How IBFs Facilitate Arbitrage

n     Arbitrage activity has been criticized

l      Results in excessive financial leverage and risk for corporations

l      Restructuring sometimes results in layoffs

n     Arbitrage helps remove managerial inefficiencies

n     Target shareholders can benefit from higher share prices

Brokerage Services

n     Market orders and limit orders

n     Short selling

n     Full-service versus discount brokerage services

l      Full-service firms provide investment advice as well as executing transactions

l      Discount brokerage firms only execute security transactions upon request

Allocation of Revenue Sources

n     Largest source of revenue has been trading and investment profits

n     Underwriting and margin interest also make up a significant portion of revenue

n     Revenue from fees earned on advising and executing acquisitions has increased over time

n     Importance of brokerage commissions has declined in recent years

Risks of Securities Firms

n     Credit risk

n     Market risk

l      Securities firms’ activities are linked to stock market conditions

l      When stock prices are rising:

u   Greater volume of stock offerings

u   Increased secondary market transactions

u   Securities firms take equity positions which are bolstered when prices rise

Risks of Securities Firms

n     Interest rate risk

l      Performance of securities firms can be inversely related to interest rate movements because:

u   Market values of bonds held as investments increase as interest rates fall

u   Lower rates can encourage investors to withdraw money from banks and invest in stocks

n     Exchange rate risk

l      Operations in foreign countries

l      Investments in securities denominated in foreign currency

Globalization of Securities Firms

n     Increased presence in foreign countries

l      Allows firms to place securities in various markets for corporations or governments

l      International mergers and acquisitions

l      Ability to handle transactions with foreign securities

n     Growth in international securities transactions

l      Created more business for large securities firms

l      International stock offerings