Chapter 24
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| How do securities firms serve as important intermediaries? | They help the govt and firms raise funds. They also facilitate the transactions between investors in the secondary mkt.
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| What kind of services do securities firms provide? | 1)Investment banks- facilitate stock and bond offerings, facilitate corporate restructuring activities. 2) brokerage firms- provide brokerage svcs for investors who want to either buy/sell various types of securities in 2nd mkt.
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| How do securities firms act as intermediaries between a corporation issuing securities and investors? | By providing the following services, origination, underwriting, distribution, and advising
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| Origination | When a corporation decides to publicly issue stock. The firm recommends the appropriate amt of stock to issue, b/c it knows the amt that wont cause reduction in stock price. evaluates the company's finances to determine stock price. Corp registers w/ SEC
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| How does the securities firm determine stock price? | If the corp has issued stock to the public before, the price should be the same as the mkt price on its outstanding stock. If not, the firm will compare the corp.'s finances w/ those of similar firms in the same industry that have issued stock.
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| Registration statement | all info relevant to the security, as well as the agreement between the issuer and the securities firm, must be provided here. This is intended to ensure that accurate info is disclosed by issuing corp.
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| Prospectus | discloses relevant financial date on the firm and provisions applicable to the security. Can only be issued after the registration is approved, which takes 20-40 days.
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| Underwriting syndicate for stock offerings | the original securities firm may form this by asking other securities frims to underwrite a portion of the stock. Each firm shares in the fees charged to the issuer.
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| Best efforts agreement | stock offerings are based on this. where the securities firm doesnt guarantee a price to the issuing corp and the corp bears the risk.
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| Whom must security firms satisfy? | w/ the IPO, they attempt to price the stock high enough to satisfy corp. Must try to satisfy institutional investors that may buy part of IPO. higher price, lower return. Firms tend to underprice the IPO. returns are seen in the very beg.
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| What type of flotation costs does a corporation incur when their stock is publicly placed in the mkt? | Flotation costs ( fees of placing the securities). 1-must pay fees to the underwriters who place the stock w/ investors. 2- it incurs issue costs including printing, legal, registration, and accounting expenses. Generally are lower for larger issues.
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| How do securities firms act as an adviser throughout the origination stage of stocks? | Even after the stock is issued, the securities firm may continue to provide advice on the timing, amt, and terms of future financing. Recommendations on the appropriate type of financing (bonds, stocks, loans)
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| Private Placement of stocks | aka direct placement is when an entire stock offering may be placed w/ a small set of institutional investors and not offered to the general public. Costs of reporting are lower than w/ public placement & underwriting svcs more manageable. no 2nd mkt
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| Origination for bonds | firm may suggest a max of bonds that should be issued. if the issuer already has a high lvl of outstanding debt, bonds may not be well recieved in mkt. 2-coupon rate, maturity, and other provisions are made, 3-register w/ SEC
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| Underwriting bonds | issuers may ask competitive bids on prices from various firms to get highest bid. Bonds can be sold large blocks to financial institutions. main issue is credit risk. if firm is nervous about guaranteeing certain price, may do best efforts agreement.
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| Flotation costs of bonds | The flotation costs generally range from 0.5 to 3% of the bonds' value issued, which can be significantly lower than the flotation costs of issuing common or preferred stock.
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| Private Placement of bonds | If issuing corp knows of a potential purchaser for its entire issue, it maybe able to sell its bonds directly w/o offering the bonds to public. Avoids the underwriting fee. Price determined by negotiations. provisions can be made to the purchaser's wants
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| Leveraged Buyouts (LBOs) | 1. firms assess the firm's mkt value of concern so that the acquirer doesnt pay more than the target firm's val. 2-arrange financing 3-help the acquirer buy any common stock of the target that is outstanding. 4-retained as advisory capacity
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| bridge loan | provides temporary financing until the acquirer of a leveraged buyout has access to other funds.
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| Arbitrage activity | the securities industry involves purchasing undervalued shares and reselling them at a higher price.
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| arbitrage firms | Securities firms work closely w/ them by searching for undervalued firms and raising funds for the arbitrage firms.
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| asset stripping | a common form of arbitrage where a firm is acquired and then its individual divisons are sold off. Motivated by the belief that the sum of the parts is sometimes greater than the whole.
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| greenmail | an arbitrage firm accumulates shares of a target w/ the expectation that the target would be willing to buy its shares back at a premium. The firm doesnt anticipate completing the takeover.
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| Facilitating corporate restructuring | Valuation of the business. Firms assess the potential val of target firms so that they can advise corps on whether to merge and on the appropriate price to offer.
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| Types of corporate restructuring | combine 2 businesses worth more than the sum of their vals separate. 2-carveout- where firm sells 1 unit to new shareholders through an IPO. proceeds go to parent firm. 3-spin off creating new shares for the unit & giving them to existing shareholders.
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| How do securities firms act as brokers? | by executing buy or sell orders desired by their customers through full service or discount brokerage services.
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| Full-service brokerage firms | provide info and personalized advice and execute orders
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| Discount-brokerage firms | only execute orders upon request and don't provide advice. often unable to maintain a long-term relationship w/ clients, b/c they provide a service difficult to differentiate from competitors.
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| What do some securities firms invest their own funds in? | invest in a wide range of securities, including stocks, bonds, mortgage-backed securities, and various types of derivatives.
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| Barings Bank | '95 Nick Leeson, a trader of currencies and excessively traded securities and suffered losses of more than $600 million of the bank's capital
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| Bear Stearns | relied heavily on borrowed funds in order to magnify its return on investment in mortgage-backed securities. return neg, losses were magnified. saved from bankruptcy by the U.S. govt.
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| Underlying causes of investment problems | huge incentive to take risks. Individuals are assigned to make investment decisions for the firm. Many firms don't have adequate controls to prevent employees from taking too much risk
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| Regulation of Securities Firms | SEC plays a big role in regulation by enforcing financial disclosure laws that attempt to ensure that investors who buy/sell securities have access to finanial info. Stk exchanges & Nasdaq mkt are expected to prevent unfair/illegal practices.
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| Who regulates the Nasdaq mkt? | Is regulated by the National Association of Securities Dealers (NASD).
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| Why is regulation of trading behavior necessary? | Regulation is necessary to ensure that investors who place orders are properly accomodated. This will establish credibility w/in the systems used to execute securities transactions.
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| Securities Investor Protection Corporation (SIPC) | offers insurance on cash & securities deposited at brokerage firms and can liquidate failing brokerage firms. Insurance limit is $500,000. The SIPC boosts investor confidence in the securities industry, economic efficiency inc, and mkt concerns are less.
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| Financial Services Modernization Act | allowed banking, securities activities, and insurance to be consolidated. No longer need to search for loopholes. resulted in the creation of more financial conglomerates and created a more competitive environment. offering of securities more efficient.
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| Regulation Fair Disclosure | requires firms to disclose any significant info simultaneously to all mkt participants. Intended to prevent firms from leaking info to analysts. Firms now provide info in the form of news releases/conference calls.
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| What are the risks of securities firms? | market risk, interest rate risk, credit risk, and exchange rate risk.
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| market risk | When stock prices rise, a greater vol of stock offerings and 2nd mkt transactions. Securities firms benefit from bullish mkt. When the stk mkt declines, stock transactions dec, causing a reduction in firms business. highly sensitive to stock mkt cycles.
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| interest rate risk | sensitive to int rate mvmts 1)bonds mkt vals held as firms investments inc as int rates decline. 2) lower int rates encourage investors to w/draw deposits & invest in stk mkt. inversely related to int rate mvmts.
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| Credit risk | The securities firms are subject to the possibility that corporations will default on their bridge loans and other types of credit. The risk tends to increase when economic conditions deteriorate.
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| Exchange rate risk | Many firms have operations in foregin countries. The earnings are reduced when the foreign currencies weaken against the parent firm's home currency. mkt values of securities decline as well.
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| Impact of the credit cris on securities firms | 1-various types of debt securities that they had bought defaulted 2-investors were less willing to particpate in mkt 3-credit mkts became inactive 4-firms couldn't borrow credit 5-fees earned by firms declined 6 stk prices plummeted, firms didnt issue stk
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| Bank Holding Companies | During the credit crisis, Goldman Sachs and Morgan Stanley (securities firms) became BHCs. the commerical banking subsidiary can accept deposits & perform the functions of banks. It creates stability for the company b/c it has steady access to deposits.
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