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Chapter 4

Chapter 4 Securities Firms and Investment Banks.docx

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FIN 701
Patricia Mc Graw

FIN701 Financial Institutions Management CHAPTER 4 Securities Firms and Investment Banks  Securities industry performs two functions: i. Raising debt and equity securities, including origination, underwriting, and placement of securities in money and capital markets for corporate and government issuers ii. Assistance in trading of securities in secondary markets including brokerage services and market-timing  Broker-dealers – securities firms that assist in trading of existing securities  Investment banks – firms specialize in originating, underwriting, and distributing issues of new securities o Includes corporate finance activities such as advising on mergers and acquisitions (M&As), as well as advising on restructuring of existing corporations SIZE, STRUCTURE, AND COMPOSITION OF THE INDUSTRY  Securities industry can be divided into integrated, institutional, retail firms based on their activities: i. Integrated firms – service retail customers (acting as broker-dealers, assisting in trading of existing securities) and corporate customers (such as underwriting, assisting in issue of new securities), institutional customers (servicing other FIs such as insurance companies, mutual funds, banks, trust companies, and pension funds)  Regulatory capital – capital margin requirements, including shareholders’ equity and subordinated debt, as defined by IIAC  Investment Industry Assocation of Canada (IIAC) – self-regulating organization (SRO) responsible for regulation of its members in Canada ii. Institutional firms – offers services to other FIs such as insurance companies, mutual funds, banks, trust companies, and pension funds  Source of income from banking activities, particularly new equity issues, and commission fees iii. Retail firms – investment advisors and brokers for retail customers  Full-service retail – provides all services to clients, including back-office functions  Retail introducer – contracts with full-service firm to carry out specified trading functions on its behalf  Discount brokers – stockbrokers that conduct trades for customers but do not offer investment advice  Specialized electronic trading securities firms provide platform for customers to trade without the use of a broker  Venture capital firms pool money from individual investors and other FIs (EX. Hedge funds, pension funds, and insurance companies) to fund relatively small new businesses  Securities firms engage in as many as seven key activity areas Investing  Managing pools of assets such as closed- and open-end mutual funds, and pension funds in competition with life insurance companies o Securities firms can manage such funds either as agents for other investors or as principals for themselves  Objective in fund management is to choose asset allocations to beat some return-risk performance benchmark Investment Banking  Activities related to underwriting and distributing new issues (primary or secondary issues) of debt and equity  Harmful practices given rise to public concerns are spinning (allocating “hot” IPO issues to executives of potential investment banking clients in exchange for investment banking business) and bias recommendations by research analysts (due to compensation being tied to success of their firms’ investment banking business)  In private offering, investment banker acts as private placement agent for a fee, placing securities with one or a few large institutional investors  In public offering, securities underwritten on best-effort or firm commitment basis o Best-effort underwriting, investment banker acts as agents on fee basis related to success in placing the issue o Firm commitment underwriting, investment banker acts as principal, purchasing securities from issuer at one price and seeking to sell at higher price Market-Making  Creating secondary market in an asset by securities firm or investment bank FIN701 Financial Institutions Management  Can involve either agency or principle transactions o Agency transaction are two-way transactions on behalf of customers o Principal transaction, market maker seeks to profit on price movements of securities and takes either long or short inventory positions for its own account (or inventory position taken to stabilize market in the securities) Trading  Closely related to market-making activities, where trader takes active net position in underlying instrument or asset  Four types of trading activities:
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