Chapter 16 Summary - book \"Financial Markets and Institutions\" PDF

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Chapter 16: Securities Firms and Investment BanksServices Offered By Securities Firms versus Investment Banks: Chapter Overview Five large investment banks at beginning of 2008 and ultimate fate Lehman Brothers bankrupt Bear Steins JP Morgan Merrill Lynch acquired B of A Goldman Sachs acquired ...

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Chapter 16: Securities Firms and Investment Banks Services Offered By Securities Firms versus Investment Banks: Chapter Overview  Five large investment banks at beginning of 2008 and ultimate fate 1. Lehman Brothers bankrupt 2. Bear Steins JP Morgan 3. Merrill Lynch acquired B of A 4. Goldman Sachs acquired bank of a 5. Morgan Stanley  converted to commercial bank holding company and goldman sachs  Serve as brokers intermediating between fund suppliers and users  Investment banking involves transactions such as the raining of debt equity  What do they do? o Origination, underwriting, placement of securities o Securities services involve assistance in the trading of securities in the secondary markets o Most recent consolidations include the acquisition of Bear Steams by JP Morgan, bankruptcy of Lehman Brothers and acquisitions of Merrill Lynch Bank of America o Mergers and acquisitions o Investment banks:  originate, underwrite, and place securities o Securities Firms:  brokerage services or market making  The largest firms, the diversified financial service or national full-service investment bankers that service both retail customers, Broker dealers, firms that assist in the trading or existing securities and corporate customers Underwriting: assisting in the issue of new securities  National full-service firms now fall into three subgroups 1. Commercial banks or financial services holding companies that are the largest of the fullest  Extensive domestic and international operations. Offer advice, underwriting, brokerage, trading, and asset management services.  Bank of American (Merrill Lynch)  Morgan Stanley  JP Morgan (Bearsterns) 2. Specialized Firms- specialize more in corporate finance or primary market activities  Ex: Goldman Sachs 3. Large Investment banks  Lazard ltd, greenhill

 Key differences between securities firms/investment banks and most other types of financial institutions o they do not transform securities, rather they serve as brokers/middlemen o ex: commercial banks deposits become loans  Rest of Industry o 1. Regional securities firms: Raymond James financial o 2. Specialized discount brokers: (effect trades without offering advice) o 3. Specialized electronic trading securities firms: (allow trades without the use of a broker through a computer network) o 4. Venture Capital/private equity firms: sequoia Capital/Bain Capital o 5. Other specialized firms: (research boutiques, floor specialists)- Capitalink LC, Duff & Phelps Security Firm and Investment Bank Activity Areas 1. Venture Capital: professionally managed pool of money used to finance new and often high-risk firms  Generally tried to back an untried company and its managers in return for an equity investment in the firm  Do not make outright loans, rather they purchase an equity interest in the firm that gives them the same rights and privileges associated with an equity investment made by the firms other owners  Institutional venture capital firms are business entities whose sole purpose is to find and fund the most promising new firms  Angel Investor: wealthy individual who make investments early in life of firm  Invest much more in new and small firms than institutional venture capital firms 2. Investment Banking: managing pools of assets such as closed and open mutual funds  Investment banking refers to activities related to underwriting and distributing new issues of debt and equity securities  Traditional  IPOs  Bond Issues  Private placement: a securities issue placed with one or a few large intuitional investors o Not required to register with the SEC 3. Market Making: creative of a secondary market in an asset by a securities firm  Agency transactions are two way transactions made on behalf of customers  Principal transactions, the market maker seeks to profit on the price movements of securities and takes either long or short inventory positions for its own account  Equity, debt, treasuries, bond, derivatives

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 Profit from spread between buying and selling  Goal is to maintain liquidity in market Trading: take an active net position in an asset  Positioning trading: involves purchases of large blocks of securities on the expectation of favorable price move. Taking a position for weeks or months waiting for a price change  Pure Arbitrage: buying an asset in one market at one price and selling it immediately in another market at a higher price  Risk Arbitrage: buying securities in anticipation of some information release- such as a merger or takeover announcements of a Federal Reserve interest rake announcement  Termed risk because if the event does not occur, the trader stands to lose money  Program trading: simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1 million, using computer programs to initiate such trades  Stock brokerage: trading of securities on behalf of individuals who want to invest in the money or capital markets  Electronic brokerage: offer by major brokers, involves direct access to the trading floor therefore bypassing broker using the internet  ***know how each of them make a profit**** Investing: managing pools of assets such as close and open end mutual funds  Can manager such funds either as agents for other investors or as principals for themselves and their stockholders  Since this business generates fees that are based on the size of the pool of assets, it tends to provide more stable flow of income than does investment banking or trading Cash Management: money market mutual duns sold by investment banks that offer check writing privileges  bank deposit-like cash management accounts, allow clients to write checks against a money market mutual fund account Mergers and Acquisitions: advise and assist on mergers and acquisitions  Identify targets or bidders, negotiate, underwrite securities, assist in valuation  Reputation Matters: more reputable advisors  better outcomes  **Know the rankings on table 16-3 and 16-4*** Other Services  Custody and escrow services, clearance and settlement services and research and advisory services- giving advice on divestitures, spin-offs and asset sales

Key Thing: most diversity in activity areas/job opportunity

Initial Public Offerings  Ex: Facebook IPO in May 2012 o Motivation: pre-IPO  Don’t know a lot out the firm before the IPO- sales/profits o During IPO: firm discloses lots of information  Basic Process (for any IPO): 1. Hire investment banker 2. Set price range and shares to be issued 3. File a prospectus with the SEC a. Disclose information about the firm (salaries, profits, conflicts of interest) 4. Organize a roadshow with investors a. Get info from investors and give info to investors 5. Build a book of indications of interest a. Ask investors how much they are willing to pay per share 6. Decide on final offer price and shares to be issued a. Final offer: 421 M shares b. $38 pre shares c. $15.998 B d. Fees to investment bankers: 7% of 15.998 B 7. Shares trade a. Primary shares (new): 180 M x $38= 6.840 B b. Secondary shares (old): 241 M x 38$= 9.158 B i. Venture capitalists, employees, early investors **Need to know how to calculate these, difference between primary shares and secondary shares Facebook initially wanted to sell 337M shares for $28-$35 per share. This included 180M new shares and 157M secondary shares

In mid-May, FB changed this to 421M shares for $34-$38 per share This includes 180M new shares and 241M secondary shares

Final offering $421M for $38 per share

Inside Facebook's IPO: From Darling to Disaster – Decoder (7 minutes), by Reuters Plus

Highlights: Early 2012, Facebook announces plans for IPO Morgan Stanley chosen as investment banker Facebook chooses to list on NASDAQ Purchase of Instagram Facebook warns that growth in mobile usage is hurting business Quarterly revenue decline May 9: Price range $28-$35 per share Morgan Stanley analyst cuts revenue forecast May 15: Raise price range $34-$38 per share GM stops advertising on Facebook May 16: Increase number of secondary shares to be sold Increases number of shares that were sold May 17: Final share price $38 determined May 18: Shares trade (after some technology glitches) on NASDAQ Morgan Stanley had to support the offer (this is part of the risk born by inv. banker) Price closes at $38.23

Key Issues in IPOs Road shows Book-building First Day Returns / Money Left on the Table  Long run average: 18% return on first day o Why???  Giving a reward to investors for helping price shares (initial investors at show)  Prospect theory- CEPs are so happy to have a large payday that they let shares go for a low price  Immoral explanation: investment banks keep price low to reward favored clients. Firms keep price low to get favorable “buy” recommendations  Facebook (unusual): o $38/share, 38.23 return of 0.6%

 Groupon (more common): o $20/share, $26.11 return of 30%...