Professional Documents
Culture Documents
24 Securities Operations
24 Securities Operations
13th Edition
by Jeff Madura
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24 Securities Operations
Chapter Objectives
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2
Functions of Securities Firms (1 of 24)
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Functions of Securities Firms (2 of 24)
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Functions of Securities Firms (3 of 24)
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Functions of Securities Firms (4 of 24)
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Functions of Securities Firms (5 of 24)
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Functions of Securities Firms (6 of 24)
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Functions of Securities Firms (7 of 24)
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Functions of Securities Firms (8 of 24)
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Exhibit 24.1 How Securities Firms
Facilitate Economic Growth
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Functions of Securities Firms (9 of 24)
Securitizing Mortgages
• Some securities firms securitize individual mortgages by
obtaining them from the financial institutions that
originate them, bundling them into packages (in
tranches) based on their risk level, hiring a credit rating
agency to assign a rating to the packages, and selling
the packages to institutional investors.
• Securitization facilitates the sale of smaller mortgage
loans that could not be easily sold in the secondary
market on an individual basis.
• Securities firms may also package mortgages with other
debt securities (such as automobile loans and credit card
loans) when engaged in the securitization process.
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Functions of Securities Firms (10 of 24)
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Functions of Securities Firms (11 of 24)
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Functions of Securities Firms (12 of 24)
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Exhibit 24.2 Participation of Securities
Firms in an Acquisition
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Functions of Securities Firms (13 of 24)
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Functions of Securities Firms (14 of 24)
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Functions of Securities Firms (15 of 24)
Proprietary Trading
• Securities firms commonly engage in proprietary (or
“prop”) trading, in which they use their own funds to
make investments for their own account.
• They may have an “equity trading desk” that takes
positions in equity securities.
• They may have a “fixed income desk” that takes
speculative positions in bonds and other debt securities.
• They may have a “derivatives trading desk” that takes
speculative positions in derivative securities.
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Functions of Securities Firms (16 of 24)
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Functions of Securities Firms (17 of 24)
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Functions of Securities Firms (18 of 24)
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Functions of Securities Firms (19 of 24)
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Functions of Securities Firms (20 of 24)
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Exhibit 24.3 Sources of Income for a
Securities Firm
INVESTMENT BANKING SERVICES
Underwriting Fees from underwriting stock offerings by firms or underwriting bond offerings by
firms and government agencies
Advising Fees for providing advice to firms about:
• Identifying potential targets
• Valuing targets
• Identifying potential acquirers
• Protecting against takeovers
Restructuring Fees for facilitating:
• Mergers
• Divestitures
• Carve-outs
• Spinoffs
BROKERAGE SERVICES
Management fees Fees for managing an individual's or a firm’s securities portfolio
Trading commissions Fees for executing securities trades requested by individuals or firms in the
secondary market
Margin interest Interest charged to investors who buy securities on margin
INVESTING ITS OWN FUNDS
Investing Profits from investing in securities
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Functions of Securities Firms (21 of 24)
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Exhibit 24.4 Interaction between Securities
Firms and Other Financial Institutions
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Exhibit 24.5 Participation of Securities
Firms in Financial Markets
TYPE OF FINANCIAL PARTICIPATION BY SECURITIES FIRMS
MARKET
Money markets • Some securities firms have created money market mutual funds, which invest in money
market securities.
• Securities firms underwrite commercial paper and purchase short-term securities for their
own investment portfolios.
Bond markets • Securities firms underwrite bonds in the primary market, advise clients on bonds to
purchase or sell, and serve as brokers for bond transactions in the secondary market.
• Some bond mutual funds have been created by securities firms.
• Securities firms facilitate mergers, acquisitions, and LBOs by placing bonds for their clients.
• Securities firms purchase bonds for their own investment portfolios.
Mortgage markets • Securities firms underwrite securities that are backed by mortgages for various financial
institutions.
Stock markets • Securities firms underwrite stocks in the primary market, advise clients on which stocks to
purchase or sell, and serve as brokers for stock transactions in the secondary market.
• Securities firms purchase stocks for their own investment portfolios.
Futures markets • Securities firms advise large financial institutions on how to hedge their portfolios with
financial futures contracts.
• Securities firms serve as brokers for financial futures transactions.
Options markets • Securities firms advise large financial institutions on how to hedge their portfolios with
options contracts.
• Securities firms serve as brokers for options transactions.
Swap markets • Some securities firms engage in interest rate swaps to reduce their exposure to interest rate
risk.
• Many securities firms serve as financial intermediaries in swap markets.
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Functions of Securities Firms (22 of 24)
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Functions of Securities Firms (23 of 24)
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Functions of Securities Firms (24 of 24)
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Regulation of Securities Firms (2 of 4)
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Regulation of Securities Firms (3 of 4)
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Regulation of Securities Firms (4 of 4)
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Valuation of a Securities Firm (1 of 3)
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Valuation of a Securities Firm (2 of 3)
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Valuation of a Securities Firm (3 of 3)
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Exhibit 24.6 Framework for Valuing a
Securities Firm
Market Risk
• Securities firms offer many services that are linked to
stock market conditions.
Interest Rate Risk
• Lower interest rates can encourage corporations or
government agencies to issue more bonds, which
requires more underwriting activity by securities firms.
• The market values of bonds held as investments by
securities firms increase as interest rates decline.
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Exposure of Securities Firms to Risk (2 of 3)
Credit Risk
• Many securities firms offer bridge loans and other types
of credit to corporations. The securities firms are subject
to the possibility that these corporations will default on
their loans.
• Securities firms that invest in mortgages and other types
of debt securities may be more exposed to credit risk.
Exchange Rate Risk
• The earnings remitted by foreign subsidiaries are
reduced when the foreign currencies weaken against
the parent firm’s home currency.
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Exposure of Securities Firms to Risk (3 of 3)
Counterparty Risk
• Security firms not only serve as intermediaries arranging
various financial transactions, but sometimes actively
participate in the transactions by taking a position
opposite to that of their client.
Impact of Financial Leverage on Exposure to Risk
• The degree to which a securities firm is exposed to the
risks just described is influenced by its financial leverage.
(Exhibit 24.7)
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Exhibit 24.7 Illustration of How Level of
Equity Affects Return on Equity
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Impact of the Credit Crisis on Securities
Firms (1 of 13)
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Impact of the Credit Crisis on Securities
Firms (2 of 13)
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Impact of the Credit Crisis on Securities
Firms (3 of 13)
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Impact of the Credit Crisis on Securities
Firms (5 of 13)
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Impact of the Credit Crisis on Securities
Firms (6 of 13)
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Impact of the Credit Crisis on Securities
Firms (7 of 13)
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Impact of the Credit Crisis on Securities
Firms (8 of 13)
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Impact of the Credit Crisis on Securities
Firms (9 of 13)
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Impact of the Credit Crisis on Securities
Firms (10 of 13)
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Impact of the Credit Crisis on Securities
Firms (11 of 13)
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Impact of the Credit Crisis on Securities
Firms (12 of 13)
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Impact of the Credit Crisis on Securities
Firms (13 of 13)
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SUMMARY (1 of 5)
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SUMMARY (2 of 5)
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SUMMARY (3 of 5)
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SUMMARY (4 of 5)
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SUMMARY (5 of 5)
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