1. All Rights ReservedDr David P Echevarria1 SECURITIES OPERATIONS CHAPTER 24

2. All Rights ReservedDr David P Echevarria2 INVESTMENT BANKING SERVICES A.Four Basic Services 1.Origination a.Registering securities with SEC 2.Underwriting (Earning the spread) a.Full b.Best Efforts 3.Advising a.Timing b.Pricing c.Terms 4.Distribution a.Public or private placement b.Function of managing underwriters c.Function of the selling syndicate. (Earn the concession)

3. All Rights ReservedDr David P Echevarria3 FUNCTIONS OF SECURITY MARKETS A.Price Discovery; arriving at fair prices 1.A security represents a promise of future payment(s) 2.Security values depend on expectations of future payment amounts a.Timing and magnitude b.Certainty (riskiness) 3.The "Market"; the Bid-Ask Spread a.Fair offer price; lowest price of the well informed trader to sell b.Fair bid price; highest price of the well informed trader to buy c.In an ideal market, all trades occur at fair prices

4. All Rights ReservedDr David P Echevarria4 FUNCTIONS OF SECURITY MARKETS B.Provide Liquidity 1.Buying and selling quickly without loss 2.A function of volume or institutional arrangements 3.Transactions should not result in a price effect C.Minimize Trading Costs: 1.Essence of security markets is trading a.Traders agree on terms of transaction b.Efficient execution of the transaction c.Exchange of securities and moneys 2.Restricting access to market; authorized traders only 3.Rules of conduct for traders 4.Standardized transactions (i.e., round lots, blocks, odd lots) 5.Provide for conflict resolution. (American Arbitration Association, 1991)

5. All Rights ReservedDr David P Echevarria5 SECURITY MARKETS ORGANIZATION A.Organized Exchanges 1.NYSE, AMEX, Tokyo (TSE), London (LSE), etc 2.Restricted participation, trading rules strictly specified 3.Traders (members) hold seats. (Specialists, Floor traders, Odd Lot traders) 4.Sale of seats must be approved (Pre-qualifications must be met.) 5.Transactions tend to be centralized; advantageous for price discovery B.Over-The-Counter (OTC) 1.NASDAQ, Government Securities, Money Markets, Foreign Exchange 2.Transactions tend to be decentralized; price discovery less efficient 3.Liquidity more expensive in terms of bid-ask spreads

6. All Rights ReservedDr David P Echevarria6 SECURITY MARKETS ORGANIZATION C.Dealer Markets vs. Auction Markets 1.Dealer market; a.Market is made by dealers who quote [trade] prices (LSE is one) b.A double auction; simultaneous offers to buy and sell 2.Auction market; orders of traders are directly matched a.A single auction; offer to buy or sell but not both 3.Some markets contain both; i.e., NYSE a.Members may act as dealers (specialists) or b.Brokers (floor traders)

7. All Rights ReservedDr David P Echevarria7 GOVERNMENT REGULATION OF SECURITIES INDUSTRY A.Regulatory Bodies 1.Securities Exchange Commission (SEC); administer laws 2.US Treasury; oversight of the Government securities market 3.Federal Reserve; set margin requirements B.Federal Legislation 1.Securities Act of 1933: must register new securities (exceptions) 2.Securities Exchange Act of 1934; Establishes the SEC 3.Commodities Exchange Act of 1936 4.Investment Advisors Act of 1940 5.Securities Investor Protection Corporation Act of 1970 6.Commodity Futures Trading Commission Act of 1974 7.Securities Acts Amendments of 1975 8.Financial Services Modernization Act of 1999

8. GLOBALIZATION OF THE SECURITIES BUSINESS A.Some Statistics: 1.1982, $249 Billion in international bonds, by 1991 $ 1,650 Billion 2.1970, 7% of US Government Securities held by foreign investors, by 12/2013, 33% 3.For China, 2013 ~ 7.6%, Japan 2103 ~ 6.7% All Rights ReservedDr David P Echevarria8

9. GLOBALIZATION OF THE SECURITIES BUSINESS A.International Firms: "passing the book" to achieve round-the-clock trading B.Lack of Uniform Regulations and Oversight an Impediment 1.Lack of confidence in foreign securities 2.Difficulties in buying/selling foreign securities 3.International Organization of Securities Commissions (IOSC) 1984 All Rights ReservedDr David P Echevarria9

10. All Rights ReservedDr David P Echevarria10 HOMEWORK QUESTIONS A.Security markets provide three important services to investors. What are they? B.How do dealer markets differ from auction markets? Does one offer an advantage over the other to traders? C.What three basic services do Investment Bankers provide to issuers of securities? D.What does "passing the book" mean and what is its significance?