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Chapter 24
Securities Operations
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
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Chapter Outline

Investment banking services

Brokerage services

Sources of income

Regulation of securities firms

Risks of securities firms

Valuation of a securities firm

Interaction with other financial institutions

Participation in financial markets

Globalization of securities firms
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Investment Banking Services
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One of the main functions of investment banking
firms (IBFs) is raising capital for corporations


The issuing corporation registers with the SEC

The registration statement is intended to ensure that
accurate information is disclosed by the issuing corporation

Included in the registration information is the prospectus,
disclosing relevant financial data on the firm and provision
applicable to the security

The IBF and the issuing firm may engage in a road show to
meet with institutional investors
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Investment Banking Services
(cont’d)

How IBFs facilitate new stock offerings (cont’d)

Underwriting
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The IBF may form an underwriting syndicate and ask other
IBFs to underwrite a portion of the stock

In a best-efforts agreement, the IBF does not guarantee a
price to the issuing corporation

During IPOs:

IBFs want to set the price high so that the issuing corporation
receives higher proceeds


How IBFs facilitate new stock offerings (cont’d)

Advising

The IBF acts as an adviser during the origination stage and
may provide advice after the stock is issued

Private placement of stocks

IBFs may be able to place an entire offering with a small set
of institutional investors

Rule 144A allows firms to engage in private placement
without the registration statement

An underwriting syndicate may not be necessary
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The issuing firm’s costs are lower
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Investment Banking Services
(cont’d)

How IBFs facilitate new bond offerings

Origination
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The IBF may suggest a maximum amount of bonds based on
existing debt levels


The issue is advertised to the public

The asking price is normally set to ensure a sale of the entire issue

Flotation costs range from 0.5 to 3 percent of the value of the
bonds
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Investment Banking Services
(cont’d)

How IBFs facilitate new bond offerings (cont’d)

Advising

IBFs may serve as advisers even after the placement is
completed
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Private placement of bonds

In a private placement, the issuing corporation sells the
issue to a purchaser of the entire issue

Avoids underwriting fees

Private placements are more common for bonds than for
stocks
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Investment Banking Services
(cont’d)



Arbitrage firms search for undervalued firms and
IBFs raise funds for these firms
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Asset stripping involves acquiring the firm and selling
its individual divisions off
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The sum of the parts is greater than the whole
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Investment 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 activity

IBFs receive fees from divestitures of divisions

IBFs may provide bridge loans if additional financing is needed

IBFs may provide advise on defense takeover tactics and finance
takeovers

Some arbitrage firms take positions in hostile takeover targets to
benefit from the expected takeover by another group

Some attempts at arbitrage fail because target firms are successful
at defending against a takeover


IBFs assess potential synergies that might result from the
combination of two businesses
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The sum of the whole is greater than the sum of the parts
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IBFs may suggest a carve-out in which the firm sells a unit of
the firm to new shareholders through an IPO by the unit
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The sum of the parts is greater than the sum of the whole

The unit may also be spun off, where new shares of the unit
are created and distributed to existing shareholders
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Investment Banking Services
(cont’d)

How IBFs facilitate corporate restructuring
(cont’d)

IBFs provide advice on mergers and acquisitions
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IBFs are critical in the valuation of the business

IBFs have loaned out their funds to companies involved in
mergers and acquisitions or even provided equity financing

The IBF can help finance an acquisition by:

Providing loans to the acquirer