FIN3244 EXAM 4 1 Securities market institutions contribute to the efficiency of financial markets through investment banks brokers and dealers and organized exchanges These institutions reduce costs of matching savers and borrowers and provide risk sharing liquidity and information services Securities market institutions are NOT financial intermediaries because they do not acquire funds from savers to invest in borrowers they only make it easier for investors to locate suitable borrowers and to reduce borrowers costs in raising funds o A Investment Banks information Assist businesses in raising new capital in primary markets and advise them on the best way to do so 1st way Investment bankers earn income through underwriting a firm s new stock or bond issue Underwriters guarantee a price to the issuing firm sell the issue at a higher price and keep the profit aka spread In exchange for spread underwriting investment bank assumes risk of not being able to resell securities 2nd way Investment bank can also sell the issue on an all or none basis In this case the company issuing the securities receives nothing unless the investment bank sells the complete issue at the offering price 3rd way best efforts Allows the investment bank to make no guarantee requiring it to sell to investors only as much of the Small issues may be underwritten by a single investment issue as it can banker Large issues are sold by groups of underwriting investment banks called syndicates Syndicated sale lead investment bank acts as manager and keeps part of the spread Remainder of spread is split among the syndicate members buying issue and to brokerage firms selling issue to public Underwriting lowers information costs between lenders and borrowers because investment banks put their reputations behind the firms they underwrite In the 1980s investment banks engaged in merchant banking they placed their own funds at risk by investing in firms that were undergoing restructuring o B Secondary Markets liquidity and risk sharing i Brokers and dealers facilitate the exchange of securities in financial markets by locating buyers when sellers want cash decrease in time and cost required in secondary markets improves liquidity in those markets Brokers earn commissions by matching ultimate buyers and sellers in a particular market Dealers trade between ultimate buyers and sellers they hold inventories of securities and sell them for a higher price than they paid for them earning the spread between the bid and asked price SEC regulates brokers and dealers to ensure disclosure of info prevent fraud and restrict trading based on insider information ii Exchanges Securities may be traded in one of two ways through exchanges or in over the counter markets Exchanges physical location at which securities are traded Don t set prices but provide way for buyers and sellers to trade anonymously lowering info costs for savers Best known are NYSE and AMEX in New York Around the world there are 142 exchanges Size of the issuing firms determines the exchange on which a stock is listed Securities of oldest largest on AMEX Those of smaller younger business firms are generally traded in over the counter markets In NYSE buyers and sellers are matched on floor by a broker dealer known as specialist who represents one or more stocks iii Over the counter trading OTC markets trading takes place over the telephone by computer Traders keep track of market by examining individual issues on their computers Member broker dealers regulate themselves through the NASD iv Trading bonds Market for US Treasury bonds and US government agency securities is most liquid market in the world Bonds usually traded on organized exchanges such as NYSE Vast majority of secondary market trading of corporate bonds is done in over the counter markets For corporate bonds the more highly rated bonds typically have the lower bid asked spreads then lower rated bonds do e trading latest source of competition for exchanges around the world provide efficient service low costs and comfort from home ECNs electronic communications networks innovative stock trading systems that rely on computer software to match buy and sell orders 2 Financial Intermediary Asset Size Finance companies intermediaries that raise large amounts of money through the sale of commercial paper and securities They use these funds to make small loans to households and businesses 3 main types of finance companies o A Consumer finance make loans to enable consumers To buy cars furniture and appliances to finance home improvements to refinance household debts consumer finance customers have higher default risk than good quality bank customers do so they are charged higher interest rates o B Business finance Engage in factoring the purchase of accounts receivable of small firms at a discount Purchase expensive equipment airplanes and lease it to businesses over a fixed length of time Doing this they specialize in gathering info about the value of collateral Factoring loans generally short term but leasing contracts can be 5 years o C Sales finance Affiliated with companies that manufacture or sell big ticket goods Purpose is to promote the business of the underlying manufacturer or retailer For example General Motors Acceptance Corporation offers financing to customers when they buy new GM cars For example Department stores issue credit cards with which customers finance purchases at those stores Sears Macy s Contractual saving institutions allow individuals to o pay money to transfer the risk of financial hardship to someone else o To save in a disciplined manner for retirement 2 different types o A Life Insurance Companies not taxed on net income two types i Mutual companies owned by policy holders The largest US life insurance firms are generally mutual companies which account for over half the industry s assets Only account for 10 of all life insurance companies ii Stock companies owned by shareholders More than 90 of insurance companies are organized as stock companies o B Property and Casualty Insurance Companies taxed on net income Because events such as natural disasters are harder to predict statistically than death rates the portfolio of these insurers largely contain liquid assets such as short term and long term credit market instruments Control assets of 2 trillion in 2006 insure policyholders against events other than death Organized as both stock and mutual companies 3 Investment Bank
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