Tài chính doanh nghiệp - Chapter 24: Securities operations

Chapter 24Securities OperationsFinancial Markets and Institutions, 7e, Jeff MaduraCopyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.1Chapter OutlineInvestment banking servicesBrokerage servicesSources of incomeRegulation of securities firmsRisks of securities firmsValuation of a securities firmInteraction with other financial institutionsParticipation in financial marketsGlobalization of securities firms2Investment Banking ServicesOne of the main functions of investment banking firms (IBFs) is raising capital for corporationsIBFs originate, structure, and place securities in the capital marketsThey serve as an intermediary rather than a lender or investorTheir compensation is typically in the form of fees3Investment Banking Services (cont’d)How IBFs facilitate new stock offeringsAn IBF acts as an intermediary between a corporation and investorsOriginationIBFs recommend the appropriate amount of stock to issueIBFs evaluate the corporation’s financial condition to determine the appropriate stock price4Investment Banking Services (cont’d)How IBFs facilitate new stock offerings (cont’d)Origination (cont’d)The issuing corporation registers with the SECThe registration statement is intended to ensure that accurate information is disclosed by the issuing corporationIncluded in the registration information is the prospectus, disclosing relevant financial data on the firm and provision applicable to the securityThe IBF and the issuing firm may engage in a road show to meet with institutional investors5Investment Banking Services (cont’d)How IBFs facilitate new stock offerings (cont’d)UnderwritingThe IBF may form an underwriting syndicate and ask other IBFs to underwrite a portion of the stockIn a best-efforts agreement, the IBF does not guarantee a price to the issuing corporationDuring IPOs:IBFs want to set the price high so that the issuing corporation receives higher proceedsIBFs do not want to set the price too high in order to place the entire issueIBFs tend to underprice IPOs6Investment Banking Services (cont’d)How IBFs facilitate new stock offerings (cont’d)Distribution of stockThe prospectus is distributed to all potential purchasers of the stockThe issue is advertised to the publicSome IBFs have brokerage subsidiaries that can sell stock on a retail levelThe corporation incurs two types of flotation costs:Fees paid to the underwritersIssue costs, including printing, legal, registration, and accounting expenses7Investment Banking Services (cont’d)How IBFs facilitate new stock offerings (cont’d)AdvisingThe IBF acts as an adviser during the origination stage and may provide advice after the stock is issuedPrivate placement of stocksIBFs may be able to place an entire offering with a small set of institutional investorsRule 144A allows firms to engage in private placement without the registration statementAn underwriting syndicate may not be necessaryThe issuing firm’s costs are lower8Investment Banking Services (cont’d)How IBFs facilitate new bond offeringsOriginationThe IBF may suggest a maximum amount of bonds based on existing debt levelsThe coupon rate, maturity, and other provisions are decidedThe asking price on the bonds will be determined by evaluating market prices of existing bondsIssuers of bonds must register with the SEC and a registration statement must be filed9Investment Banking Services (cont’d)How IBFs facilitate new bond offerings (cont’d)Underwriting bondsSome issuers may solicit competitive bids on the price of bonds from various IBFsIBFs provide several services to the issuerUnderwriting spreads on newly issued bonds are normally lower than on newly issued stockThe IBF may organize an underwriting syndicate to participate in placing the bondsDistribution of bondsA prospectus is distributed to all potential purchasersThe issue is advertised to the publicThe asking price is normally set to ensure a sale of the entire issueFlotation costs range from 0.5 to 3 percent of the value of the bonds10Investment Banking Services (cont’d)How IBFs facilitate new bond offerings (cont’d)AdvisingIBFs may serve as advisers even after the placement is completedPrivate placement of bondsIn a private placement, the issuing corporation sells the issue to a purchaser of the entire issueAvoids underwriting feesPrivate placements are more common for bonds than for stocks11Investment Banking Services (cont’d)How IBFs facilitate leveraged buyoutsIBFs assess the market value of the firm IBFs arrange financing, which involves raising funds and purchasing any common stock outstanding that is held by the publicIBFs may be retained in an advisory capacityIBFs may purchase a portion of the firm’s assets to provide financial supportExposes the IBF to a high degree of riskMerrill Lynch has designed a mutual fund that finances LBOsPurchase junk bonds of firms that went privateProvides bridge loans that offer temporary financing to firms until junk bonds can be issued12Investment Banking Services (cont’d)How IBFs facilitate arbitrageArbitrage activity involves the purchasing of undervalued shares and the resale of those shares for a higher profitArbitrage firms search for undervalued firms and IBFs raise funds for these firmsAsset stripping involves acquiring the firm and selling its individual divisions offThe sum of the parts is greater than the whole13Investment Banking Services (cont’d)How IBFs facilitate arbitrage (cont’d)IBFs generate fee income from advising arbitrage firms and receive a commission on the bonds issued to support the arbitrage activityIBFs receive fees from divestitures of divisionsIBFs may provide bridge loans if additional financing is neededIBFs may provide advise on defense takeover tactics and finance takeoversSome arbitrage firms take positions in hostile takeover targets to benefit from the expected takeover by another groupSome attempts at arbitrage fail because target firms are successful at defending against a takeover14Investment Banking Services (cont’d)How IBFs facilitate arbitrage (cont’d)History of arbitrage activitySometimes arbitrage firms have accumulated shares of targets with the expectation that targets will buy back the shares at a premiumGreenmailSome IBFs helped to finance greenmailArbitrage activity has been criticized because:It often results in excessive financial leverage and risk for corporationsThe restructuring of divisions after acquisitions results in layoffs15Investment Banking Services (cont’d)How IBFs facilitate corporate restructuringIBFs provide advice on corporate restructuringIBFs assess potential synergies that might result from the combination of two businessesThe sum of the whole is greater than the sum of the partsIBFs may suggest a carve-out in which the firm sells a unit of the firm to new shareholders through an IPO by the unitThe sum of the parts is greater than the sum of the wholeThe unit may also be spun off, where new shares of the unit are created and distributed to existing shareholders16Investment Banking Services (cont’d)How IBFs facilitate corporate restructuring (cont’d)IBFs provide advice on mergers and acquisitionsIBFs are critical in the valuation of the businessIBFs have loaned out their funds to companies involved in mergers and acquisitions or even provided equity financingThe IBF can help finance an acquisition by:Providing loans to the acquirerUnderwriting bonds or stock for the acquirerInvesting their own equity in the acquirer’s purchase of the target17Brokerage ServicesMarket orders are requests by customers to purchase or sell securities at the market price existing when the order reaches the exchange floorLimit orders are requests by customers to purchase or sell securities at a specified price or betterSpecialists monitor limit orders and execute transactions in accordance with the limits specifiedIf investors order a sale of securities when the price reaches a specified minimum, it is a stop-loss order18Brokerage Services (cont’d)Short selling involves the sale of securities investors do not ownUsed to speculate on expectations of a decline in securities pricesShort sellers are required to reimburse the owners of the stock for any missed dividendsFull-service versus discount brokerage servicesFull-service brokerage firms provide information and advice as well as executing transactionsDiscount brokerage firms only execute transactions upon requests and do not provide adviceThe required minimum opening balance is typically between $1000 and $3,000Most discount brokers offer some degree of research on a website19Brokerage Services (cont’d)Online ordersThe implementation of an online order system has reduced costs of brokerage firmsOnline trading has become very competitivePrices charged are low, typically $25 or less for 100 shares of stock20Sources of IncomeInvestment Banking ServicesUnderwritingFees from underwriting stock or bond offeringsAdvisingFees for advice to firms about identifying potential targets, valuing targets, identifying potential acquirers, protecting against takeoverRestructuringFees for facilitating mergers, divestitures, carve-outs, spin-offsBrokerage servicesManagement feesFees for managing securities portfoliosTrading commissionsFees for executing trades securities requested by individual or firms in the secondary marketMargin interestInterest charged to investors who buy securities on marginInvesting its own fundsInvestingProfits from investing in securities21Sources of Income (cont’d)Income allocation among securities firmsThe proportion of income derived from each source varies among securities firms in any particular yeare.g., when IPOs are hot, income from underwriting fees will be highSome securities firms emphasize investment banking and therefore generate a high proportion of income from underwriting and advising feese.g., Goldman SachsSome firms emphasize brokerage and generate a higher proportion of income from trading commissionse.g., Charles SchwabMany securities firms attempt to diversify their services so that they can capitalize on economies of scope22Sources of Income (cont’d)Impact of the September 11 Crisis on revenue sourcesTrading profits declined because stock prices declinedThe attack led to more uncertainty and reduced the number of IPOs and secondary offeringsThe volume of acquisitions declined23Regulation of Securities FirmsSecurities firms are subject to a variety of regulationsThe SEC attempts to ensure that investors have access to financial informationThe SEC has power to ensure that publicly-traded companies provide sufficient financial information to existing or prospective investorsThe SEC tends to establish general guidelines that can affect trading on security exchanges24Regulation of Securities Firms (cont’d)Stock exchanges and the Nasdaq are expected to prevent unfair or illegal practices, ensure orderly trading, and address customer complaintsStock exchanges are responsible for the day-to-day regulation of exchange tradingStock exchanges have regulatory divisionsThe Nasdaq market is regulated by the NASDSurveillance departments monitor trading patterns and behavior by specialists or market makers and floor tradersEnforcement divisions investigate possible violations and can enforce disciplinary actions25Regulation of Securities Firms (cont’d)The Fed determines margin requirementsThe Securities Investor Protection Corporation (SIPC) offers insurance on cash and securities deposited at brokerage firms and can liquidate failing brokerage firms All brokers registered with the SEC are assessed premiums by the SIPCThe insurance limit is $500,000, including $100,000 against claims on cashThe SIPC has a $500 million revolving line of credit and can borrow up to $1 billion from the SEC26Regulation of Securities Firms (cont’d)Financial Services Modernization ActThe Act allowed banking, securities activities, and insurance to be consolidated in a financial holding companyThe Act resulted in the creation of more financial conglomerates that included securities firmsA primary benefit to securities firms is cross-listingThe bundling of financial services can generate more business for each type of financial institution that is part of the conglomerate27Regulation of Securities Firms (cont’d)Regulation FD:Was enacted in October 2000 by the SECRequires that firms disclose any significant information simultaneously to all market participantsWas partially intended to prevent a firm from leaking information to analystsPrevented analysts working for securities firms to have a competitive information advantageBenefited analysts who relied on their own analysis28Regulation of Securities Firms (cont’d)Rules regarding analyst compensation and ratingsWhen firms need underwriting or advisory services, they are more likely to hire a securities firm whose analyst would rate the stock highlyThe compensation of some analysts in the 2001–2002 period was sometimes aligned with the new business they brought inAnalysts were tempted to inflate the ratings of stocks and investors were misled29Regulation of Securities Firms (cont’d)Rules regarding analyst compensation and ratings (cont’d)In 2002, the SEC implemented new rules:If a securities firm underwrites an IPO, it cannot use its analysts to promote the stock for the first 40 days after the IPOAnalyst compensation cannot be directly aligned with the amount of business that the analyst bring to the securities firmAnalysts cannot be supervised by the investment banking department within the securities firmAn analyst rating must divulge any recent investment banking business provided by the securities firm that assigned the rating30Regulation of Securities Firms (cont’d)Rules preventing abuse in the IPO marketIn the 2001–2003 period various abuses occurred:Some securities firms that served as underwriters allocated shares to corporate executives who were considering an IPO for their firm (spinning)Some securities firms that served as underwriters encouraged institutional investors to place bids for the shares on the first day that are above the offer price in order to be allowed to participate in the next IPOThe SEC investigated cases of abuse and imposed finesThe SEC enacted rules to prevent such abuses from occurring in the future 31Regulation of Securities Firms (cont’d)Repeal of the trade-through ruleSpecialists were sometimes able to jump ahead of other orders (called penny-jumping)Prevented other investors from having their orders executedIn 2004, the SEC ruled that investors could circumvent the trade-through rule to avoid penny-jumping by specialistsMutual fund disclosureIn 2003, some funds were allowing their large clients to buy or sell shares after the 4 p.m. closing but at the 4 p.m. prices (late trading at stale prices)Violates 1968 SEC lawsThe SEC imposed heavy fines on those mutual funds and is working on laws requiring more disclosure of the fees that mutual funds charge and better governance 32Risks of Securities FirmsMarket riskWhen stock prices are rising there is a greater volume of stock offerings and secondary market transactionsSecurities firms benefit from a bullish stock marketSome take equity positions in the stocks they underwriteSome take a partial equity interest in target firmsAcquisitions tend to be more common in bullish marketsInterest rate riskThe market values of bonds held as investment by securities firms increase as interest rates declineLower interest rates can encourage investors to withdraw deposits from banks and invest in the stock market33Risks of Securities Firms (cont’d)Credit riskSecurities firms offer bridge loans and other types of credit to corporationsDefault risk increases during periods when economic conditions deteriorateExchange rate riskMany securities firms have operations in foreign countriesEarnings remitted by foreign subsidiaries are reduced when the foreign currencies weaken against the parent firm’s home currencyMarket values of foreign investments decline as the currencies weaken against the parent firm’s home currency34Valuation of a Securities FirmThe value of a securities firm is the present value of its future cash flowsThe value should change in response to changes in expected cash flows and the required rate of return:Factors that affect cash flows:35Valuation of a Securities Firm (cont’d)Economic growthEconomic growth increases the level of income of firms and households and can increase the demand for the firm’s servicesThe volume of brokerage activity increasesBusiness expansion increasesDebt securities are less likely to defaultEquity securities should perform wellChange in the risk-free interest rateThe valuation of a securities firm is inversely related to interest rate movementsAssets are adversely affected by rising interest rates36Valuation of a Securities Firm (cont’d)Change in industry conditionsAffected by regulations, technology, and competitionReduced regulations may increase expected cash flowsIncreased competition from reduced regulations may reduce expected cash flowsChange in management abilitiesManagers can attempt to make decisions that will capitalize on external forces the firm cannot controlSecurities firms need skillful management to create new financial services that may complement the brokerage services they already offer37Valuation of a Securities Firm (cont’d)Factors that affect the required rate of return by investors:The risk-free rate is positively related to inflation, economic growth, and the budget deficit level, but inversely related to money supply growthThe risk premium is inversely related to economic growth and the company’s management skillsRegulatory constraints may discourage firms from taking excessive riskLoosening of regulatory barriers to entry may increase the risk of securities firms38Type of Financial InstitutionInteraction with Securities FirmCommercial banks and SIsCompete with commercial banks and SIs for brokerage servicesCompete with commercial banks offering advice on M&As and underwriting commercial paperMutual fundsExecute trades for mutual fundsSome mutual funds are organized by securities firmsMutual funds purchase newly issued securities Insurance companiesAdvise portfolio managers of insurance companies on tradesExecute securities transactions for insurance companiesAdvise portfolio managers on hedging interest rate and market riskUnderwrite stocks and bonds purchased by insurance companiesCompete with insurance companies in the sales of mutual fundsObtain financing on LBOs from insurance companiesHave acquired or merged with insurance companiesInteraction with Other Financial Institutions39Type of Financial InstitutionInteraction with Securities FirmPension fundsAdvise pension fund portfolio managers in tradesExecute securities transactions for pension fundsAdvise pension fund portfolio managers on hedging interest rate and market riskPension funds purchase newly issued securitiesInteraction with Other Financial Institutions (cont’d)40Type of Financial MarketParticipation by Securities FirmsMoney marketsSome firms have created money market mutual fundsUnderwrite commercial paper and purchase short-term securitiesBond marketsUnderwrite bonds, advise clients on bonds to purchase or sell, serve as brokers for secondary market transactionsSome bond mutual funds have been created by securities firmsFacilitate mergers, acquisitions, and LBOsPurchase bonds for their own investment portfoliosMortgage marketsPlace securities backed by mortgages for financial institutionsStock marketsUnderwrite stocks, advise clients on what stocks to purchase or sell, serve as brokers for secondary market transactionsPurchase stocks for their investment portfoliosParticipation in Financial Markets41Type of Financial MarketParticipation by Securities FirmsFutures marketsAdvise large financial institutions on how to hedge their portfolios with futuresServe as brokers for financial futures transactionsOptions marketsAdvise large financial institutions on how to hedge portfolio with optionsServe as brokers for options transactionsSwap marketsEngage in interest rate swaps to reduce their exposure to interest rate riskServe a financial intermediaries in swap marketsParticipation in Financial Markets (cont’d)42Participation in Financial Markets (cont’d)Competition between securities firms and commercial banksCommercial banks can offer discount brokerage services at lower fees than full-service feesCommercial banks compete with discount brokersCommercial banks must either establish a brokerage subsidiary or acquire a brokerage firmRecently, some securities firms have provided loans to businesses43Globalization of Securities FirmsIn 1986, the Big Bang allowed for deregulation in the U.K.Many securities firms have increased their presence in foreign countriesCommercial banks from the U.S. have established investment banking subsidiaries overseasAdvantages of becoming internationalizedAllows firms to place securities in various countriesAllows firms to benefit from international M&AsInstitutional investors investing in foreign securities prefer firms that can easily handle such transactions44Globalization of Securities Firms (cont’d)Growth in international joint venturesSecurities firms have expanded internationally by engaging in joint venturesAllows foreign market penetration with a limited stakeSecurities firms facilitate privatizations of firms in foreign markets such as Latin America and EuropeGrowth in international securities transactionsThe growth in international securities transactions has created more business for the larger securities firmsGrowth in Latin AmericaGrowth in Japan45