1. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-1 McGraw-Hill/Irwin Chapter Sixteen Securities Firms and Investment Banks

2. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-2 McGraw-Hill/Irwin Services Offered by Securities Firms versus Investment Banks Investment Banks –originating, underwriting, and placing securities in money and capital markets Securities Firms –brokerage services or market making The largest companies in the industry perform multiple services (e.g., underwriting and brokerage) and are generally called investment banks Investment Banks –originating, underwriting, and placing securities in money and capital markets Securities Firms –brokerage services or market making The largest companies in the industry perform multiple services (e.g., underwriting and brokerage) and are generally called investment banks

3. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-3 McGraw-Hill/Irwin Size, Structure, and Composition of the Industry Three major types of firms –national full-line investment banks that service retail and corporate customers (e.g., Merrill Lynch) –national full-line firms that specialize in corporate finance (e.g., Goldman Sachs) –the remainder of the industry specialized investment bank subsidiaries of commercial banks specialized discount brokers regional securities firms specialized electronic trading securities firms venture capital firms Three major types of firms –national full-line investment banks that service retail and corporate customers (e.g., Merrill Lynch) –national full-line firms that specialize in corporate finance (e.g., Goldman Sachs) –the remainder of the industry specialized investment bank subsidiaries of commercial banks specialized discount brokers regional securities firms specialized electronic trading securities firms venture capital firms

4. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-4 McGraw-Hill/Irwin Securities Firm and Investment Bank Activity Areas Securities firms and investment banks engage in as many as seven key activity areas –Investing –Investment Banking –Market Making –Trading –Cash Management –Mergers and Acquisitions –Other Service Functions Securities firms and investment banks engage in as many as seven key activity areas –Investing –Investment Banking –Market Making –Trading –Cash Management –Mergers and Acquisitions –Other Service Functions

5. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-5 McGraw-Hill/Irwin Investing Involves managing pools of assets such as mutual funds Compete with commercial banks, life insurance companies, and pension funds Manage funds either as agents for other investors or as principals Objective is to select asset portfolios to beat some return-risk performance benchmark such as the S&P 500 Involves managing pools of assets such as mutual funds Compete with commercial banks, life insurance companies, and pension funds Manage funds either as agents for other investors or as principals Objective is to select asset portfolios to beat some return-risk performance benchmark such as the S&P 500

6. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-6 McGraw-Hill/Irwin Investment Banking Refers to activities related to underwriting and distributing new issues of debt and equity securities Industry is dominated by a small number of underwriting firms Securities underwriting can be undertaken through either public or private offerings –Private placement –Public placement Refers to activities related to underwriting and distributing new issues of debt and equity securities Industry is dominated by a small number of underwriting firms Securities underwriting can be undertaken through either public or private offerings –Private placement –Public placement

7. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-7 McGraw-Hill/Irwin Market Making Involves the creation of a secondary market in an asset by a securities firm or investment bank Either agency or principal transactions –Agency transactions –Principal transactions Involves the creation of a secondary market in an asset by a securities firm or investment bank Either agency or principal transactions –Agency transactions –Principal transactions

8. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-8 McGraw-Hill/Irwin Trading Closely related to market-making activities Six types of trading –Position trading –Pure Arbitrage –Risk Arbitrage –Program Trading –Stock Brokerage Electronic Brokerage Closely related to market-making activities Six types of trading –Position trading –Pure Arbitrage –Risk Arbitrage –Program Trading –Stock Brokerage Electronic Brokerage

9. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-9 McGraw-Hill/Irwin Cash Management cash management accounts (CMAs) –money market mutual fund sold by investment banks that offer check-writing privileges cash management accounts (CMAs) –money market mutual fund sold by investment banks that offer check-writing privileges

10. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-10 McGraw-Hill/Irwin Mergers and Acquisitions Frequently provide advice on, and assistance in, mergers and acquisitions –assist in finding merger partners –underwrite any new securities –asses the value of target firms –recommend terms of the merger agreement –assist target firms in preventing a merger Frequently provide advice on, and assistance in, mergers and acquisitions –assist in finding merger partners –underwrite any new securities –asses the value of target firms –recommend terms of the merger agreement –assist target firms in preventing a merger

11. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-11 McGraw-Hill/Irwin Other Service Functions Custody and escrow services Clearance and settlement services Research and advisory services Custody and escrow services Clearance and settlement services Research and advisory services

12. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-12 McGraw-Hill/Irwin Balance Sheet Assets, 2004 Assets Cash $ 50,744.0 1.28% Receivable from other broker-dealers 1,530,227.0 38.44 Receivable from customers 163,159.2 4.10 Receivables from noncustomers 18,345.8 0.46 Long positions in securities/commodities 1,075,696.7 27.02 Securities and investments not marketed 11,753.1 0.30 Securities purchased w/resell agreement 967,008.0 24.29 Exchange membership 1,086.6 0.03 Other assets 162,346.1 4.08 Total assets $3,980,375.4 100.00 Assets Cash $ 50,744.0 1.28% Receivable from other broker-dealers 1,530,227.0 38.44 Receivable from customers 163,159.2 4.10 Receivables from noncustomers 18,345.8 0.46 Long positions in securities/commodities 1,075,696.7 27.02 Securities and investments not marketed 11,753.1 0.30 Securities purchased w/resell agreement 967,008.0 24.29 Exchange membership 1,086.6 0.03 Other assets 162,346.1 4.08 Total assets $3,980,375.4 100.00

13. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-13 McGraw-Hill/Irwin Balance Sheet Liabilities, 2004 Liabilities Bank loans payable $ 75,548.8 1.90% Payables to other broker-dealers 842,983.0 21.18 Payables to noncustomers 66,995.6 1.68 Payables to customers 407,432.6 10.23 Short positions in securities/commodities 510,513.0 12.82 Securities sold w/repurchase agreements 1,565,003.7 39.32 Other nonsubordinated liabilities 286,459.8 7.20 Subordinated liabilities 75,921.7 1.91 Total liabilities $3,830,858.1 96.24 Capital Equity capital 149,517.3 3.76 Number of firms 6,549 Liabilities Bank loans payable $ 75,548.8 1.90% Payables to other broker-dealers 842,983.0 21.18 Payables to noncustomers 66,995.6 1.68 Payables to customers 407,432.6 10.23 Short positions in securities/commodities 510,513.0 12.82 Securities sold w/repurchase agreements 1,565,003.7 39.32 Other nonsubordinated liabilities 286,459.8 7.20 Subordinated liabilities 75,921.7 1.91 Total liabilities $3,830,858.1 96.24 Capital Equity capital 149,517.3 3.76 Number of firms 6,549

14. ©2007, The McGraw-Hill Companies, All Rights Reserved 16-14 McGraw-Hill/Irwin Regulation The primary regulator of the securities industry is the Securities and Exchange Commission (SEC) SEC sets rules governing securities firms’ underwriting and trading activities Shelf registration The Securities Investor Protection Corporation (SIPC) The primary regulator of the securities industry is the Securities and Exchange Commission (SEC) SEC sets rules governing securities firms’ underwriting and trading activities Shelf registration The Securities Investor Protection Corporation (SIPC)