Securities Firms Mutual Funds and Financial Conglomerates Chapter

Securities Firms, Mutual Funds, and Financial Conglomerates Chapter 20 © 2003 South-Western/Thomson Learning

Learning Objectives ¨ What securities firms are and what financial services they provide ¨ Various types of mutual funds ¨ What are hedge funds and real estate investment trusts (REITs) ¨ Role of government-sponsored enterprises (GSEs) ¨ What financial conglomerates are and why they have grown so much in recent years 2

Securities Firms The two main functions of securities firms are investment banking and the buying and selling of previously issued securities. ¨ Investment Banks § Financial institutions that design, market and underwrite new issuances of securities in primary market § Responsibilities for New Offerings-two types § Initial Public Offering (IPO) - not previously sold financial stocks or bonds to public § Seasoned Issuance – when stocks or bonds have been previously issued § Timing 3

Securities Firms ¨ Investment Banks § Role of Securities and Exchange Commission § Registration Statement § Statement that must be filed with the SEC before new securities offering can be issued § Prospectus § Subpart of registration statement that must be given to investors before they purchase securities § Credit Rating § Underwriting and Marketing § Syndicate § Group of investment banks § Each underwrites a proportion of new securities offering 4

Securities Firms ¨ Investment Banks and Functioning of Primary Market § Private Placement § Method of issuing new securities by selling to limited number of large investors 5

Brokers & Dealers: Secondary Market ¨ Types of Orders – to instruct broker / dealer § Market Orders § Purchase or sell the securities at present market price § Limit Orders § Purchase securities at market price up to certain maximum § Short Sell § Borrow shares of stocks § Sell them today with guarantee that investor will replace them by a date in future 6

Brokers & Dealers: Secondary Market ¨ Margin Loans § Loans to investors § Proceeds are used to purchase securities ¨ Brokerage Fees § Brokerage firms could compete by offering lower fees § Discount brokerage firms § Provide limited or no investment advice § Fees much lower that full-service brokerage firms 7

Securities Industry Self-regulated by National Association of Securities Dealers (NASD) and various securities exchanges such as the New York and American stock exchanges. ¨ Securities Industry Protection Corporation (SIPC) § Nonprofit membership corporation § Established by Congress in 1970 § Provides insurance up to $500, 000 per investor 8 § To protect investors’ securities from liquidation by brokerage firm

Investment Companies that own and manage a large group of different mutual funds. ¨ Open-End Fund § Mutual fund continually sells new shares to public § Buys outstanding shares from public § At price equal to the net asset of value § Difference between market value of shares of stock that mutual fund owns and liabilities of mutual fund ¨ 9 Closed-End Fund § Mutual fund sells limited number of shares like other corporations § Usually do not buy back outstanding shares

Investment Companies ¨ Load § Sales commission § Paid to broker to purchase mutual finds § By law, load cannot exceed 8. 5% ¨ No-Load § Mutual funds purchased directly from mutual fund company § Not subject to a load 10

Growth of Investment Funds ¨ ¨ ¨ Recent legislation gives individuals control over where their pension funds are invested, many have chosen mutual funds Many types of mutual funds are often offered by single investment company Create new funds that invest in several mutual funds § Fund of Funds § Mutual fund § Invests in portfolio of other mutual funds rather than individual stocks and/or bonds 11

Growth of Investment Funds ¨ Stock § § § § 12 Funds Aggressive growth funds Global equity funds Growth and income funds Income-equity funds Index funds Sector funds Socially conscious funds

Exhibit 20– 3 a A Sample of the Types of Mutual Funds 13

Growth of Investment Funds ¨ Bond § § § § 14 Funds Corporate bond funds Global bond funds Ginnie Mae funds High-yield bond funds Long-term municipal bond funds State municipal bond funds U. S. government income funds

Exhibit 20– 3 b A Sample of the Types of Mutual Funds 15

Growth of Investment Funds ¨ Stock § § 16 and Bond Funds Balanced funds Flexible portfolio funds Income-mixed funds Convertible securities funds

Exhibit 20– 3 c A Sample of the Types of Mutual Funds 17

Hedge Funds ¨ ¨ ¨ 18 Nontraditional type of MF that attempt to earn maximum returns regardless of rising or falling financial prices General partner usually organizes fund and is responsible for day-to-day trading decisions Not regulated as traditional investment pools or mutual funds Attempt to earn high - or maximum - returns Use riskier investment strategies than those in traditional mutual funds Traditionally charge high fees and take large percent of profits

Real Estate Investment Trusts (REITs) ¨ Special type of mutual fund ¨ Pools funds of many small investors ¨ Uses them to buy or build income property ¨ Uses them to make or purchase mortgage loans 19

Government-Sponsored Enterprises Publicly held corporations that are chartered by Congress. ¨ GSE Housing Market § Federal National Mortgage Association (Fannie Mae) § Federal Home Loan Mortgage Corporation (Freddie Mac) § Government National Mortgage Association (Ginnie Mae) 20

Government-Sponsored Enterprises ¨ GSE Farm Loan Market § Federal Farm Credit Banks Funding Corporation (FFCBFC) § Issues bonds and discount notes to make loans to farmers § Federal Credit Financial Assistance Corporation (FACO) § Issues bonds with explicit government guarantee § Uses proceeds to assist the FFCBFC 21

Government-Sponsored Enterprises ¨ GSE Student Loan Market § Student Loan Marketing Association (Sallie Mae) § Issues securities to purchase student loans § Increases the amount and liquidity of funds flowing into student loans ¨ Financing Corporation (FICO) § Issues bonds § Uses proceeds to help resolve the savings and loan crisis 22

Financial Conglomerates ¨ ¨ Own and operate several different types of financial intermediaries and institutions Alleged advantages of forming financial conglomerates include taking advantage of § Economies of scale - gains from size that may result from several firms § Streamline management § Eliminate duplication of effort of several separate firms § Economies of scope § Advantages to firms being able to offer customers several financial services under one roof § Diversification § Branching out of financial conglomerates into several product lines 23