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1、Ch 4 Securities Firms (Based on Saunders et al,2006)Outline1.Definition2.Quick Facts3.Dimensions of Investment Banking and Activities4.Balance Sheet5.Examples of Derivatives6.Regulations7.Venture Capital8.Conclusions11.SecuritiesFirmsnAlso called investment dealers(Canada)Main functions:1.Help issue
2、rs raisefunds by selling debt,equity,and derivative securities directly toultimateinvestors(investment banking)2.Help investors in the trading of securities (broker/dealers)22.QuickFactsnThe Canadiansecuritiesindustry plays a key role in assisting corporations and governments to raise capitalnIn 200
3、1 the securitiesdealeraffiliates of the sixmajor domestic banks and one major U.S.dealer,generated over 70 per cent of the industrys revenues.With the current financial meltdown it has decreased drastically.nSignificant growth in 1990s;at end of 2008 included 216 firms nToronto Stock Exchange(TSX)Eq
4、uity exchange 1,541 listed stocks;Market capitalization C$1.3 trillion(March 2009)Approximately 300 firms are cross-listed in major U.S.exchanges(Nasdaq,NYSE,Amex).Currently,it is very costly to list and issue equity in the US to comply with corporate governance regulations such as the Sarbanes-Oxle
5、y Act enacted to avoid the occurrence of fraudulent firms,e.g.,Enron.3nMontreal Exchange(ME).Derivatives:stock index options,bond futures and stock options(e.g.161 options on stocks May 2009.n TSXVentureExchange:2,269 listings junior equity;market capitalization C$20.7 billion(March 2009).nCNSX.Cana
6、dian National Stock Exchange:48 issues with Market capitalization above C$1 billion)4Toronto Stock Exchange Volume and Transactions(2004-2008)VolumeTransactions200440.3billion61.3million200555.264.2.7200685.782.02007118.696.12008182.9109.2CAGR16%CAGR46%5Bankownershipofintegratedinvestmentdealers(ID)
7、(Endof2003)nFirm(ID)MajorityownernBMO Nesbitt Burns IncBank of MontrealnCIBC World Markets Inc CIBCnNational Bank Financial IncNational Bank of CanadanRBC Capital MarketsRoyal Bank of CanadanScotia Capital IncThe Bank of Nova ScotianTD Securities IncTD Bank Financial GroupnThe Big Six(Canadian comme
8、rcial banks)hold about a 70%of the securities-brokerage business.6Top Canadian Investment Firms,2004*2003,all others 200473.Dimensions of Investment Banking(1)Integrated firmsnBroker/dealersnUnderwritingnServices to other FIs(2)Institutional firmsnInvestment services provided primarily to other FIs(
9、3)Retail firmsnInvestment advisors/brokers for retail customersnDiscount broker.nFull-service broker(itmayinvolvediscretiononinvestorswealthmanagement)8nGiving AdviceWhen to offer?At what price?nUnderwritingSyndicatenMarketing OutcomesFully subscribed UndersubscribedOversubscribedActivities(1).Under
10、writing IPOs,SEOs,Private placements,commercial paper of private firms,government debt n Types of Underwritinga)Firm commitment(Bought deals in Canada)b)Best Effortsn Filing Documents Registration statement(Co.information to regulatory authorities)Prospectus(Information to investors-summary)9Example
11、 of a bond underwritingRBC Capital Markets agrees to underwrite a 10-year$1 billion,4%annual coupon rate for BCE Inc on a firm commitment basis.RBC pays BCE on Thursday and plans to begin a public sale on Friday.What type of interest rate movement does the investment bank fear while holding these se
12、curities?Assume the current market interest rate is 4%.If the interest rate rise 0.05%,overnight determine:a)The current price of the bond on Thursday.b)The price at which it has to sell the bond(next day)if the interest rate rises 0.05 overnight?c)The impact on profits?d)Redo b and c if the market
13、interest rate falls 5 basis points?10(2).Marketmaking Maintaining a secondary market in the asset viaAgency transaction:Brokered on behalf of clients for a commission.Principal transaction:Take position in a transaction(change in its inventory of securities)They are called Specialists in the NYSE an
14、d Dealers in the NASDAQRegistered Traders in the TSXExampleofStockandElectronicBrokerage(See Fig.A)(3).MergersandAcquisitions(example Chrysler-Daimler)11InvestorBroker(Merrill Lynch)Commission orFloor BrokerMarket Maker(Specialist)Order 1OrderOrderShares 2SharesSharesCashCashCashFig.A Purchase of a
15、Stock on the NYSETransaction settled in 3 days2.Internet trading.The trades goes directly to the Floor Broker1.From your broker 312(4).TradingPositiontrading Long and short positions(usually large blocks of securities)nPureArbitrage Riskless profit obtained by simultaneously buying and selling asset
16、s with same risk.(See Fig.B)nRiskArbitrage Usually involving the purchase(acquired)and(short)sale (acquirer)of companies shares involved in mergers if the deal goes through.13180 daysS=106.00/$106,000,000Eurodollar rate=8.00%per annumDollar money market$1,000,000$1,040,000 1.04Start End Yen money ma
17、rket 108,120,000 1.02Euroyen rate=4.00%per annumFig.B Example of Pure Arbitrage:Covered Interest Arbitrage(CIA)F180=103.50/$(fair 103.96)(for each youll get$0.009662)ArbitragePotential$1,044,6551.Borrow$1 million and convert it to Yen(106/$)2.Invest in proceeds in Yen at 2%for 180 days.3.Simultaneou
18、sly sell the future Yen proceeds 108,120,000 forward for dollars at the 180-day forward rate of F180=103.50/$108,120,000*0.0099662=$1,044,6554.Costs of funds in US dollars$1,040,000 Profit=$4,655 =4655/(1+.04)=$4,474 PRESENT VALUE14 Example of Program TradingnProgramtradingArbitrage opportunities be
19、tween a cash market price(e.g.,the price of the stocks in the S&P/TSX 60)and the futures market price of that index via computerized programs.For example this would occur if the value of the actual futures market price is higher than its fair value.NumericalExample(seealsoFig.C)CurrentvalueofStocksi
20、ntheS&P/TSX60=1,484pointsCurrentvalueofthefuturesmarketpriceoftheS&P/TSX60indexfor(cash)deliveryonemonthlater=1,527(vs.Theoretical valueof1,509).Strategy:BuytheSTOCKSintheS&P/TSX60at1,484(viaacomputerizedprogram)andSimultaneouslySELLTHEINDEXintheFUTURESmarketforcashdeliveryonemonthlaterRegardlessReg
21、ardlessRegardlessRegardless ofofwhatwilltheactualvalueoftheS&P/TSX60beattheendofonemonthProfit1,527-$1,484=43434343pointsor43/1,484=2.90%(minusT.Costsof0.5%)=2.4%ForexampleiftheS&P/TSX60attheendofthreemonthsis1,500thearbitrageurwillmake16pointsonthestocks(=1,500-1,484)and27pointsonthefuturesposition
22、(1,527-1,500).such that 16+27=43points15Example of Program TradingFig.CTodayValue of S&P/TSX end of one month =1,500 or 1,450 Buy stocks of S&P/TSX 60 at 1,484 points Sell one-month Index futures contract at 1,527(Theoretical value of 1,509 points)Sell stocks of S&P/TSX at 1,500Profit=?Receive cash
23、for the sale of Index Futures Contract=1,527Profit=?TOTAL=One month later Net return(%)=Gross Return Transaction Costs=43/1,484 0.005=0.024 or 2.4%Strategy16(5).Cash Management and Banking ServicesnFacilitate clients to invest in sharesBorrowing on marginOnline access to banking and investment accou
24、ntsnPrivate banking:Investment advice and financial planning to wealthy individuals6.InvestingnManagement of mutual funds and pension fundsnInvesting on their own behalf7.OtherServiceFunctionsClearance,and settlement services,Research and Advisory Services174.TypicalBalanceSheetofsecuritiesfirms(200
25、4)AssetsCash,Marketablesecurities,andreceivables-includingreversereposLiabilitiesReposTradingliabilities(mostlyborrowingsecuritiesforshortselling)LongTermborrowingEquity(Approx50%ofassets)CommonsharesContributedSurplusRetainedearningsOff-Balance-SheetactivitiesDerivativesandCreditsubstitutes185.Exam
26、pleofDerivativesnForwardContractItisacommitmenttodaytotransactinthefuture.Purchase or sale of a specific commodity or financial asset at a currentspecifiedprice,with delivery and settlement at a specified future date.nFuturesContractIt is a standardized forward contract traded in a standardized forw
27、ard market called FuturesMarket.Standards:Contract size,delivery dates,prices,conditions of delivery(e.g.in commodities)0Sale of bonds currently held at the specified price of$200 million for delivery at the end of the year 1Deliver bonds and receive$200 million19 Example Derivatives:HedgingnAssume
28、an investment bank(IB)has a position in a bond maturing at the end of 2010 of$210 Million.nThe marketexpectedinterest rate in 2010 is 5%nIt promised to invest$200 million in a venture capital investment at the end of 2009 with the proceeds of the bond sale.nHowever,the bankexpects the interest rate
29、will increase in 1 percent to 6%.This will decrease the value of the bond to less than$200.nWhat should the Investment bank do?A:?ProcedureDetermine the value of the bonds at the end of 2010 with i=5%If the interest rate increases to 6%(1%increase)what is the value of the bonds?Sell the bonds where?
30、20Hedging:Bond Example End 2010(maturity date)End 2009(Deliver bonds and invest promised$200 million in venture project)$210Market ExpectedInterest rate=5%?Today(Sell$200 million of bonds through a futures contract)IB ExpectedInterest rate=6%If IB does not hedge via a futures contract and the intere
31、st rate increases to 6%,what would be the value of the bonds at the end of 2009?216.RegulationsFederal and provincially regulatedOntario Securities Commission(OSC)Licensing/monitoringReviewer prospectus and other filingsInvestigates violations(e.g.,insider trading)Canadian Securities Administrators(
32、13)Pressure to form a single national securities regulator.International Organization of Securities CommissionCoordination of securities markets at the intl level22nSelf-Regulatory Organizations Toronto Stock Exchange(TSX),Montreal Exchange(ME);www.m-x.caInvestment Industry Regulatory Organization o
33、f Canada.“National self-regulatory organization which oversees all investment dealers and trading activity on debt and equity marketplaces in Canada”www.iiroc.ca23nTenlargeststockexchangesbymarketcapitalizationofdomesticcompaniesMarketcapitalizationofdomesticcompaniesatFeb.2005Exchange(billionsofU.S
34、.dollars)nNewYorkStockExchange11,329nTheNasdaqStockMarket2,844nTokyoStockExchange*2,953nLondonStockExchange2,460nEuronext(Paris,Amsterdam,Brussels and Lisbon stock exchanges,and LIFFE)2,076nDeutscheBrse1,079nTorontoStockExchange889nItalianExchange527nSWXSwissExchange(jointlywiththeDeutscheBoerseitow
35、nsEurextheworldlargestfuturesandoptionsexchangeJan2005)727nHongKongExchangesandClearingLimited715*Stockmarketdownbyover70%formitshighin1989(NationalPost,5Jan05)Source:WorldFederationofExchanges.24Ten largest stock exchanges by market capitalization of domestic companies ExchangeUSD bnUSD bn%Change%C
36、hange end-2008end-2007In USDIn local currency1NYSEEuronext(US)9,20915,651-41.2%-41.2%2TokyoStockExchangeGroup3,1164,331-28.1%-41.4%3NASDAQOMX2,3964,014-40.3%-40.3%4NYSEEuronext(Europe)2,1024,223-50.2%-47.8%5LondonStockExchange1,8683,852-51.5%-33.4%6ShanghaiStockExchange1,4253,694-61.4%-64.0%7HongKon
37、gExchanges1,3292,654-49.9%-50.2%8DeutscheBrse1,1112,105-47.2%-44.6%9TMXGroup1,0332,187-52.7%-41.8%10BMESpanishExchanges9481,781-46.8%-44.1%Source:World Federation of Exchanges.257.Venture CapitalRiskcapital provided by outside investors to young,private firms(entrepreneurs)with superior growth poten
38、tial.Why no bank loans?Mostly hightech sector(E.g.,Apple computer,Cisco Systems,Genetech,Microsoft,Netscape,Sun Microsystems,Dell.Others:Staples and Starbucks)Venture capitalists invest in the form of subordinated debt,convertible debt,preferred shares and equity.Seatontheboard.Involved in advice,mo
39、nitoring and control of strategic company decisions26Expected realizedreturn within 5-10 years usually trough an IPO(up to 4 times original investment)20%annualreturn on a 20-year average period U.S.Venture capitalist may be a department of Investment bank,subsidiary of bank,independent FI,Instituti
40、onal venture capitalist Obtainthemoney usually from pension funds,corporations,wealthy individuals.AngelCapital.Initial capital for an entrepreneur to start a business278.ConclusionsnInvestment banks are financial institutions which main function is help issuers raisefunds(primarymarket)toultimatein
41、vestors.It helps investors to trade securities(brokerage)in the stock market(secondary market).nMost Canadian investment banks are owned by the largest 6 Canadian banks.nCurrently,many investments banks are settling with securities regulators for their involvement in failed corporations such as Enron,WorldCom,ParmalatnThe market capitalization of companies listed in the TSX represents about 3%of the total market worldwide.28