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Chapter SixteenSecurities 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 placingsecurities 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 asadvising 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 ofthe 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 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 insurancecompanies, 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 transactionsAgency 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 offavorable price move

Pure Arbitrage - buying an asset in one market and selling itimmediately in another market at a higher price

RiskArbitrage - buying securities in anticipation of someinformation 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, directaccess 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 1.51%

Receivable from other broker-dealers 1,204,448.8 35.72Receivable from customers 177,945.9 5.28

Receivables from noncustomers 15,757.7 0.47

Long positions in securities/commodities 838,254.9 24.86

Securities and investments not marketed 10,550.0 0.31

Securities purchased w/resell agreement 856,043.4 25.39

Exchange membership 1,034.2 0.03

Other assets 216,,624.5 6.43

Total assets $3,371,641.7 100.00

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Balance Sheet Liabilities

LiabilitiesBank loans payable $ 76,191.9 2.26%

Payables to other broker-dealers 629,858.6 18.68

Payables to noncustomers 59,910.5 1.78

Payables to customers 391,543.1 11.61

Short positions in securities/commodities 409,342.3 12.14Securities sold w/repurchase agreements 1,282,870.8 38.05

Other nonsubordinated liabilities 302,757.3 9.16

Subordinated liabilities 68,710.4 2.04

Total liabilities $3,227,184.9 95.72

CapitalEquity capital 144,456.7 4.28

Number of firms 7,029

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Regulation

The primary regulator of the securities industry is theSecurities and Exchange Commission (SEC) establishedin 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 submitone registration statement summarizing the firms

financing plans for the period The Securities Investor Protection Corporation (SIPC)

protects investors against losses of up to $500,000 onsecurities firm failures