1. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-1 4 Chapter The Financial Services Industry: Securities Firms and Investment Banks

2. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-2 Overview u In this segment... Securities Firms and Investment Banks: Activities of securities firms and investment banks Size, structure and composition Balance sheets and recent trends Regulation of securities firms and investment banks Global issues

3. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-3 Securities Firms and Investment Banks u Nature of business: Underwrite securities. Market making. Advising (example: M&A, restructurings). u Growth in mergers and acquisitions: Less than $200 billion in 1990. $1.83 trillion in 2000 Decline in 2001

4. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-4 The Largest M&A Transactions

5. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-5 Size, Structure and Composition Dramatic increase in number of firms from 1980 to 1987. Decline of 24% following the 1987 crash, to 2000. 1987: Salomon Brothers held $3.21 billion in capital. 2000: Merrill Lynch held capital of $19.3 billion. Many recent inter-industry mergers (i.e., insurance companies and investment banks). »Role of Financial Services Modernization Act, 1999

6. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-6 Types and Relative Sizes of Firms National full-line firms are largest. National full-line firms specializing in corporate finance are second in size. Remainder of industry: »Specialized investment subsidiaries of BHCs. »Discount brokers. »Regional securities firms (subdivided into large, medium and small). »Specialized electronic trading securities firms

7. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-7 Top U.S.Underwriters, 2000

8. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-8 Key Activities Investing Investment banking »Activities related to underwriting and distributing new issues of debt and equity. Market making Trading »Position trading, pure arbitrage, risk arbitrage, program trading

9. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-9 Key Activities (continued) Cash management Assisting with mergers and acquisitions Back-office and service functions.

10. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-10 Trends u Decline in trading volume and brokerage commissions particularly since crash of 1987, although some recovery since 1992. Record volumes 1995-2000. u Decline in underwriting activities over 1987-90. u Resurgence in activity and profitability 1991- 2000.

11. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-11 Trends (continued) u Increases in holdings of fixed-income trading greater interest rate and sovereign risk exposure u Pretax profits soared to $21.0 billion in 2000 curtailed by economic slowdown and September 11 attacks u 1987: Federal Reserve allowed BHCs to expand securities underwriting. Prohibited since 1933 under Glass-Steagall Act.

12. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-12 Balance Sheet u Key assets: Long positions in securities and commodities. Reverse repurchase agreements. u Key liabilities: Repurchase agreements major source of funds. Securities and commodities sold short. Broker call loans from banks u Capital levels much lower than levels in banks

13. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-13 Regulation u Primary regulator: SEC Reiterated by National Securities Markets Improvement Act (NSMIA) of 1996. Prior to NSMIA, regulated by SEC and states. Regulate trading activities such as shelf registration u Day-to-day trading practices regulated by the NYSE and NASD.

14. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-14 Investor Protection & Other Monitoring u Securities Investors Protection Corporation (SIPC). Protection level of $500,000 u Federal Reserve also has role in overseeing securities firms and investment banks Vulnerability of the financial system Issue of timely settlement

15. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-15 Web Resources u For details of regulation of securities firms and investment banks, visit: SEC: www.sec.gov NYSE: www.nyse.com NASD: www.nasd.com SIPC: www.sipc.org Web Surf

16. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-16 Global Issues u Growth in securities trading and underwriting is a global event u Other countries were not encumbered by regulations such as Glass-Steagall Act Foreign banks operating in the U.S. compete with U.S. commercial and investment banks

17. ©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 4-17 Pertinent Websites Federal Reserve: www.federalreserve.gov NASD: www.nasd.com NYSE: www.nyse.com SEC: www.sec.gov Securities Industry Association: www.sia.com SIPC: www.sipc.org The Banker: www.thebanker.com Thompson Fin. Securities Data: www.tfsd.com Web Surf