Securities Firms

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Securities Firms

• Mutual Funds Overview
• Mutual Funds Basics
• Performance Evaluations
• Hedge Funds
• Underwriting
• Brokerage Service

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Overview of Securities Firms Business

• Investment Banking Business
• Brokage Service
• Investment Funds
• Mutual Funds
• Hedge Funds

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Mutual Fund Overview

• Management/investment company
• e.g., Fidelity Management and Research
  Corporation, a subsidiary of Fidelity Investments
• Providing investment advice
• Mutual Funds independent directors
• Have independent directors
• Transfer agent (servicing existing fund
  shareholders)
• Underwriter/distributor (selling funds)
• Fund Managers
• Fund brokers
• Fund custodians

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Fund Types

• Open-end funds versus close-end funds
• Open-end Fund shares can be redeemed at any
  time at a price that is tied to the asset value
  of the fund (net asset value, abbreviated as
  NAV). When we talk about mutual fund, we usually
  refer to open end fund
• Closed-end fund a fixed number of
  nonredeemable shares are sold at an initial
  offering and then traded in OTC market like a
  common stock. Price of share could be different
  from NAV.
• UIT
• Exchange-traded funds.

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Fund Types

• Based on investment objectives (way to create
  peer group)
• Morningstar has 48 categories (Morningstar
  StyleMap)
• Lipper has 91 categories (Lipper Style box
  classification)
• Means to compare fund performance
• Is a fund necessarily good if it consistently
  outperforms SP 500 for 5 years?

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Mutual Fund Types

• Balanced Funds
• Bond Funds
• Value Funds low P/E, P/B, M/B ratio
• Growth Funds high growth, P/E, P/B, M/B
• Growth and Income Funds high Div payout
• Index Funds low fee, diversified
• - exchange traded funds (ETFs)
• Money Market Mutual Funds low risk, high
  liquidity
• - T Rowe Price Associate

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Fee Structure

• No-Load Funds
• funds without sales commissions/front-end
  charges
• Load Funds
• funds with sales commissions/front-end
  charges

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Fees in addition to Front loads

• Back-end load/Redemption fee/deferred load
• Contingent deferred sales charge (CDSC)
• 12b-1 fee
• Covering distribution costs, advertising and
  marketing expense, limited to 1 per year
• Operating expense
• Costs incurred in operating the portfolio,
  measured by expense ratio (0.2-2)
• Management fee
• 12b-1 fees
• Exchange fee
• Account maintenance fee

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Fund Classes

• Funds from alternative classes have the same
  portfolio of securities but impose different
  combination of fees. Investors select the best
  combination of fees
• Class A shares sold with front-end loads of
  4-5, no 12b-1 fee
• Class B shares impose 12b-1 charges and back-end
  loads
• Class C shares dont impose back-end redemption
  fees, but have 12b-1 fees higher than those in
  class B (1)
• Class D shares include front end loads and 12-1
  charges of 0.25
• Class I shares institutional shares (no
  front-end charge and low annual operating
  expense)
• Fee and loads contingent on scale of investment
• Breakpoint Dollar levels of investment in a fund
  that qualify you for reduced sales charges.

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Break Points

• Class A shares have a front-end load 8.5 while
  decrease depending on the amount of money you
  initially invest
• 0 9,999 8.5
• 10,000 24,999 7.75
• 25,000 - 49,999 6.25
• 50,000 99,999 4.00
• 100,000 and up 0.00

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Disclosure Requirement

• Funds are registered with SEC, providing
• Prospectus (1) objective
• (2) fees and expenses
• (3) investment strategy
  and risk
• (4) how to buy and sell
• Shareholder Report
• (1) fund performance
• (2) fund financial
  statement
• (3) required to report
  semiannually

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Calculating Mutual Fund Return

• Net Asset Value (NAV)
• Total value of the mutual funds stocks,
  bonds, cash, and other assets minus any
  liabilities such as accrued fees, divided by the
  number of shares outstanding.
• Return

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Fund NAV and Return

• Stocks 35,000,000
• Bonds 15,000,000
• Cash 3,000,000
• Total value of assets 53,000,000
• Liabilities -800,000
• Net worth 52,200,000
• Outstanding shares 15 million
• NAV

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Now suppose value of stocks increases to 40
million, and that of bonds increases to 20
million, while other things being equal what is
new NAV? What is return of the
fund? Stocks Bonds Cash total value of
assets liabilities net worth shares
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Performance measures

• Sharpe ratio
• Treynor measure
• Jensen measure

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Hedge Funds

• 1. Take advantage of unusual spreads between
  security prices
• Long undervalued securities, short overvalued
  securities
• Market-neutral investment
• 2. Often highly leveraged
• Using leverage to increase ROE
• 3. Strong managerial incentive
• Fund managers receive 1 annual management fee,
  14 annual profit when fund return exceeds high
  water mark
• 4. Relatively unregulated
• Domestic hedge fund (fewer than 100 investors,
  limited partnership)
• Offershore hedge funds (non-U.S. corporations),
  not subject to SEC regulations

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Investment Banking

• Investment banks major responsibility is to
  assist in the initial sale of securities in the
  primary market, namely, underwriting stocks and
  bonds
• Include both IPOs and seasoned offers
• Glass-Steagall Act separates commercial banking
  from investment banking

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Underwriting Stocks and Bonds

• Giving Advice
• When to offer?
• At what price?
• Filing Documents
• SEC
• Registration statement
• Prospectus
• Underwriting
• Syndicate
• Tombstones
• Marketing Outcomes
• Fully subscribed
• Undersubscribed
• Oversubscribed
• Best Efforts

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Ten Largest Underwriters in the U.S.
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Other Investment Banking Service

• Private Placement
• Mergers and Acquisitions
• Active in this market since 1960s
• Serves both acquirers and target firms

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Securities Brokers and Dealers

• Brokerage Service
• a. Securities Orders
• Market Order
• Limit Order buy with maximum acceptable
• price and
  sell with minimum price
• short sell
• b. Other Services
• Margin Credit
• brokage-based cash
  management account
• c. Full-Service Brokers provide research and
  investment advice
• d. Discount Brokers execute trades on request
• Securities Dealers
• Market Makers increase market liquidity

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Box 1 Using the Limit-Order Book
Unfiled Circuit City Limit Orders ________________
__________________ Buy Orders Sell Orders
37 100 37.125 300 37.25
100 37.375 200 37.50
500 37.625 100 Any deal now?
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Orders 1. 200-share market buy order 2.
300-share limit sell order at 37.125 3.
500-share limit buy order at 36.875 The order
book is
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Short-selling borrow shares Joel shorts 200
shares of IBM stocks at 50/share. Later on the
stock price goes to 40/share. How much
profit/loss Joel has made in this transaction?
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Buy-on-margin borrow money Amy bought 10,000
shares of IBM stocks at 50/shares with her
margin account. The IBM price increases to 60
later. How much profits/losses Amy could make?