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