Investment Banking, branch of finance concerned with the underwriting, distribution, and maintenance of markets in securities issued by business firms and public agencies. Investment bankers are primarily merchants of securities; they perform three basic economic functions:
(1.) provide capital for corporations and local governments by underwriting and distributing new issues of securities;
(2.) maintain markets in securities by trading and executing orders in secondary market transactions; and
(3.) provide advice on the issuance, purchase, and sale of securities, and on other financial matters. In contrast to commercial banks, whose chief functions are to accept deposits and grant short-term loans to businesses and consumers, investment bankers engage primarily in long-term financing.
In addition to departments handling the purchase and resale of new issues, an investment-banking house typically has a trading department, a brokerage department, and a research or statistical department.
The trading department buys and sells securities when profitable opportunities arise. Sometimes it may have to buy back securities it is marketing in order to prevent a decline in their market price.
The brokerage department buys and sells securities, at a commission, for the accounts of other investors. The research department supplies the firm and its customers with information about securities.
An important segment of investment-banking operations is carried on by government-bond dealers. A few dozen large investment houses and commercial banks, most of them headquartered in New York City, handle the bulk of trading in U.S. government securities.
Thursday, March 5, 2009
Margin Deals
Margin Deals, in finance, transactions in which a purchaser buys securities by paying a percentage of the price and pledging the securities to guarantee payment of the balance of the price.
For example, an investor pays a broker a specified sum (margin) toward the purchase of shares of stock.
The broker advances as a loan the remainder of the money needed to purchase the shares.
If the price of the stock remains constant or rises, the broker's loan is protected.
If the price begins to fall, the broker notifies the investor that the stock will be sold unless an additional margin is advanced.
For example, an investor pays a broker a specified sum (margin) toward the purchase of shares of stock.
The broker advances as a loan the remainder of the money needed to purchase the shares.
If the price of the stock remains constant or rises, the broker's loan is protected.
If the price begins to fall, the broker notifies the investor that the stock will be sold unless an additional margin is advanced.
IPO's and the Secondary Market
Corporations issue new securities in what is known as the primary market, usually with the help of investment bankers. The investment bank acquires the initial issue of the new securities from the corporation at a negotiated price and then makes the securities available for its clients and other investors in an initial public offering (IPO).
In this primary market, corporations receive the proceeds of security sales. After this initial offering the securities are bought and sold in the secondary market. The corporation is not usually involved in the trading of its stock in the secondary market. Stock exchanges essentially function as secondary markets.
By providing investors the opportunity to trade financial instruments, the stock exchanges support the performance of the primary markets. This arrangement makes it easier for corporations to raise the funds that they need to build and expand their businesses
In this primary market, corporations receive the proceeds of security sales. After this initial offering the securities are bought and sold in the secondary market. The corporation is not usually involved in the trading of its stock in the secondary market. Stock exchanges essentially function as secondary markets.
By providing investors the opportunity to trade financial instruments, the stock exchanges support the performance of the primary markets. This arrangement makes it easier for corporations to raise the funds that they need to build and expand their businesses
Computerized Transfer of Ownership
Most of the world’s major exchanges have become highly efficient, computerized organizations. Each has a charter for regulating operations and some are integrated within regional economic unions.
For instance, the EU was instrumental in organizing the EASDAQ and drafted its charter.
In addition, exchanges now trade securities from companies around the world.
Computerization has enabled brokers to instantaneously monitor activities on foreign exchanges.
Many exchanges also list indexes and averages—such as the Nikkei 225 Stock Average of the Tokyo Stock Exchange (TSE) and the Financial Times Stock Exchange 100 of the LSE—that are closely followed by options and futures investors.
For instance, the EU was instrumental in organizing the EASDAQ and drafted its charter.
In addition, exchanges now trade securities from companies around the world.
Computerization has enabled brokers to instantaneously monitor activities on foreign exchanges.
Many exchanges also list indexes and averages—such as the Nikkei 225 Stock Average of the Tokyo Stock Exchange (TSE) and the Financial Times Stock Exchange 100 of the LSE—that are closely followed by options and futures investors.
Stock Trading
Stocks are shares of ownership in companies. People who buy a company’s stock may receive dividends (a portion of any profits).
Stockholders are entitled to any capital gains that arise through their trading activity—that is, to any gain obtained when the price at which the stock is sold is greater than the purchase price.
But stockholders also face risks. One risk is that the firm may experience losses and not be able to continue the payment of dividends.
Another risk involves capital losses when the stockholder sells shares at a price below the purchase price.
Stockholders are entitled to any capital gains that arise through their trading activity—that is, to any gain obtained when the price at which the stock is sold is greater than the purchase price.
But stockholders also face risks. One risk is that the firm may experience losses and not be able to continue the payment of dividends.
Another risk involves capital losses when the stockholder sells shares at a price below the purchase price.
Bonds Finance
From an investor's perspective, stocks offer a higher potential return if profits rise, but bonds are generally a safer investment.
Stock dividends are paid out of company profits, while bond interest payments are made even if the company is losing money.
If a corporation goes bankrupt, bondholders must be paid before stockholders. Nonetheless, risks are associated with investing in bonds.
Because most bonds offer a fixed rate of return, a bond with a low coupon rate will be less valuable if interest rates rise to the point that the investor's money could be more profitably invested elsewhere.
If the inflation rate rises in relation to the coupon rate, the value of the investor's return will be reduced.
Stock dividends are paid out of company profits, while bond interest payments are made even if the company is losing money.
If a corporation goes bankrupt, bondholders must be paid before stockholders. Nonetheless, risks are associated with investing in bonds.
Because most bonds offer a fixed rate of return, a bond with a low coupon rate will be less valuable if interest rates rise to the point that the investor's money could be more profitably invested elsewhere.
If the inflation rate rises in relation to the coupon rate, the value of the investor's return will be reduced.
Federal Reserve Bank Stock
At the base of the Federal Reserve System are the member commercial banks.
All national, or federally chartered, banks are required to join the system; membership of state-chartered institutions is voluntary.
Members have to purchase capital stock in their district Federal Reserve bank in the amount of 6 percent of their capital, excluding retained earnings, and get the right to vote for six of the nine directors of that district bank.
Stock ownership does not convey control or the financial interest normally attached to stock in a corporation. The stock may not be sold or used as collateral and must be returned to the district reserve bank if the commercial bank ceases to be a member.
All national, or federally chartered, banks are required to join the system; membership of state-chartered institutions is voluntary.
Members have to purchase capital stock in their district Federal Reserve bank in the amount of 6 percent of their capital, excluding retained earnings, and get the right to vote for six of the nine directors of that district bank.
Stock ownership does not convey control or the financial interest normally attached to stock in a corporation. The stock may not be sold or used as collateral and must be returned to the district reserve bank if the commercial bank ceases to be a member.
Power of Government to Regulate
The precise scope of police power is difficult to define.
It covers, for example:
It covers, for example:
- The maintenance of the peace by the police.
- The licensing of some trades and professions.
- The regulation of rates charged by public service corporations.
- The regulation of security issues by so-called Blue Sky laws, which are statutes intended to prevent fraud in the sale of stocks and bonds.
- The regulation of hours of labor; and such health regulations as quarantine and compulsory vaccination.
Federal Reserve Regulation
The Federal Reserve also has a narrow role in regulating operations of the stock market.
It may selectively lower or raise the margin requirement, which is the percentage of a stock price that must be provided in cash by someone who buys the stock on credit.
The margin requirement, a legacy of depression legislation, aims to curb market speculation.
It may selectively lower or raise the margin requirement, which is the percentage of a stock price that must be provided in cash by someone who buys the stock on credit.
The margin requirement, a legacy of depression legislation, aims to curb market speculation.
Finance and the stock exchange
A wide variety of financial institutions have different roles in finance and the economy. Some institutions, such as banks, link lenders and borrowers.
These institutions act as an intermediary among consumers, businesses, and governments by lending out deposits.
Other institutions, such as stock exchanges, provide a market for existing securities, which include stocks and bonds.
Stock exchanges encourage investment because they enable investors to sell their securities when the need arises.
These institutions act as an intermediary among consumers, businesses, and governments by lending out deposits.
Other institutions, such as stock exchanges, provide a market for existing securities, which include stocks and bonds.
Stock exchanges encourage investment because they enable investors to sell their securities when the need arises.
Stock Split
Stock Split, an increase or decrease in the number of shares of stock issued by a corporation. When corporations issue a stock split, they change the value of the stock in proportion to the change in the number of shares so that the total value of the stock remains the same.
Many stock splits are 2 for 1—that is, investors get two shares of stock for each share they own.
For example, an investor who held 100 shares of General Electric with a value of $120 a share prior to a 2 for 1 stock split, would hold 200 shares with a value of $60 a share after the split. Companies sometimes issue stock splits to lower the price of their stock if they believe that a lower price will entice more investors to buy the stock.
A corporation may also issue a reverse stock split in which the number of shares is cut in half, but the value of each share is doubled. In a reverse split, 100 shares of stock with a value of $5 a share would become 50 shares with a par value of $10 a share.
Reverse stock splits raise the price of the stock and are most common with low priced stocks. A company might make a reverse split to increase the price per share to meet the requirements for listing the stock on a stock exchange.
Splits and reverse splits may be made in any amount. Occasionally, a company will make splits in the amount of 3 for 1, 4 for 1, or even 10 for 1.
Many stock splits are 2 for 1—that is, investors get two shares of stock for each share they own.
For example, an investor who held 100 shares of General Electric with a value of $120 a share prior to a 2 for 1 stock split, would hold 200 shares with a value of $60 a share after the split. Companies sometimes issue stock splits to lower the price of their stock if they believe that a lower price will entice more investors to buy the stock.
A corporation may also issue a reverse stock split in which the number of shares is cut in half, but the value of each share is doubled. In a reverse split, 100 shares of stock with a value of $5 a share would become 50 shares with a par value of $10 a share.
Reverse stock splits raise the price of the stock and are most common with low priced stocks. A company might make a reverse split to increase the price per share to meet the requirements for listing the stock on a stock exchange.
Splits and reverse splits may be made in any amount. Occasionally, a company will make splits in the amount of 3 for 1, 4 for 1, or even 10 for 1.
Stock Options
Stock Option, an option or right to buy or sell stock at a specified price, usually within a specified period of time. The buyer of a stock option can choose to take action on the option—that is, to exercise it—within the specified period of time or to not take action and let the option expire.
Sometimes the term stock option refers specifically to options that a company grants its employees as compensation in addition to their salaries.
For example, a company may give an employee stock options that allow the employee to buy 100 shares of company stock at the present-day price of $40 per share at any time within the next ten years.
If the stock should rise to $50 per share, the employee can choose to exercise the option—that is, put it into effect. The employee can then buy 100 shares of company stock at $40 per share for $4000. The employee can either hold onto the stock or sell it at $50 per share for $5000, for a profit of $1000.
If the stock price should fall, the employee is not obligated to buy the stock at $40 per share. Stock options are becoming a common way for companies to reward their employees.
Sometimes the term stock option refers specifically to options that a company grants its employees as compensation in addition to their salaries.
For example, a company may give an employee stock options that allow the employee to buy 100 shares of company stock at the present-day price of $40 per share at any time within the next ten years.
If the stock should rise to $50 per share, the employee can choose to exercise the option—that is, put it into effect. The employee can then buy 100 shares of company stock at $40 per share for $4000. The employee can either hold onto the stock or sell it at $50 per share for $5000, for a profit of $1000.
If the stock price should fall, the employee is not obligated to buy the stock at $40 per share. Stock options are becoming a common way for companies to reward their employees.
Issuing New shares
An existing corporation that wants to secure funds to expand its operations has three options. It can issue new shares of stock, using the process described earlier.
That option will reduce the share of the business that current stockholders own, so a majority of the current stockholders have to approve the issue of new shares of stock.
New issues are often approved because if the expansion proves to be profitable, the current stockholders are likely to benefit from higher stock prices and increased dividends.
Dividends are corporate profits that some companies periodically pay out to shareholders.
That option will reduce the share of the business that current stockholders own, so a majority of the current stockholders have to approve the issue of new shares of stock.
New issues are often approved because if the expansion proves to be profitable, the current stockholders are likely to benefit from higher stock prices and increased dividends.
Dividends are corporate profits that some companies periodically pay out to shareholders.
How stock price is determined
The price of a stock depends on the market forces of supply and demand. With companies issuing only a limited number of shares, price is determined by demand.
An increase in demand will raise the price whereas a decrease in demand will lower the price. Normally the demand for a particular stock depends on expectations regarding the profits of the corporation that issued the stock.
The more optimistic these expectations are, the greater the demand will be and, therefore, the greater the price of the stock
An increase in demand will raise the price whereas a decrease in demand will lower the price. Normally the demand for a particular stock depends on expectations regarding the profits of the corporation that issued the stock.
The more optimistic these expectations are, the greater the demand will be and, therefore, the greater the price of the stock
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