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Introduction to Securities Industry Professor Goodfellow: Ok, now that you've seen how this course will run, let

's meet some of the players that make this process possible and comprise the Investment World. We'll start with those who issue securities, take a look at the people who want to get money from their investments, and then look at those who manage these investment transactions. Then we'll introduce you to the products that people invest in and how these products are issued or traded. We'll wrap up your introduction to the Investment World with the basic terms and concepts that we'll encounter throughout this course on the Fundamentals of the Securities Industry.

The Investment World
The People

Issuers Investors Financial Industry Professionals

The Major Products

Traditional Secondary

Terms/Concepts The Basic Processes

Raising Capital Choosing the Investment Banker The Syndicate Full Disclosure The Cooling-Off Period Distributing the Security

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Learning Objectives: After completing this module, you'll be able to:

Gain a basic understanding of the investment world and the Securities Industry Understand the role of Primary and Secondary Markets Understand the process of a Public Offering

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The Issuer:

Harry Allen: Alright, now here's where I'd like to come in. I'm Harry Allen, I'll be telling you about the way things work in the real world. You got your IBMs, you got your mom-'n-pop shops. But all corporations need capital to replace plants and equipment, launch new business ventures, and bridge gaps in their cash flow. Governments also need capital for replacing buildings and equipment, for building roads and bridges, and for sustaining government operations until expected revenues materialize.

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People: The Investors

Individual investors are interested in the securities industry for a variety of reasons: the author whose earnings vary from year to year, and who needs a steady flow of investment income; the couple who want to establish a fund for their children's college education; the professional who is doing well now and is willing to put some earnings in high—risk, high—gain investments; and the couple who just sold a car and need to "park" their money temporarily until they find another car to buy.

Individual Investors want to:

ensure a steady income establish a fund for future use invest extra cash for high gains use securities as a money-management tool

In recent years, institutions of various sorts have come to play an enormously influential role in the investment world. Institutions invest in securities for a variety of reasons: one organization might need to invest for their employee pension funds to provide pension payments in the future; another organization might need to invest a short-term cash surplus. Institutional Investors might need to:

invest pension funds for future pension payments temporarily invest a short-term cash surplus

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and investment bankers. corporations. "Wall Street". Page 5 of 30 . including the general public. Together these professionals represent the bulk of what people tend to lump together with the shorthand term. regulators monitor the industry as a whole. and governments need representatives to act on their behalf in transacting business: the brokers. In addition. They are responsible for setting the ground rules and protecting all the parties. the securities industry needs people and places that bring them together: the markets and the market makers.People: Financial Industry Professionals So that transactions among the participating parties can proceed efficiently. traders. Examples of regulatory authorities. Finally. investors.

Investment banker: Firm acting as underwriter or agent that serves as intermediary between as issuer of securities and the investing public. a market maker is an NASD member firm that disseminates bid and ask prices at wchich it stands ready to buy stock into. On the stock exchanges.Market Maker Synonymous with an OTC dealer. Late in 2008 all of the largest Investment Banks in America received Commercial Bank charters. the market maker maintains bid and ask prices in options contracts. On the CBOE. At this time it appears that they will continue to perform all of the tasks traditionally performed by Investment Banks as well as some functions traditionally performed by Commercial Banks. . and sell stock from. See also underwriting agreement. its inventory at its own risk in the over-the-counter market. the Specialist performs the function of market maker as well as handling the book of public orders.


Let's have a look at the many types of securities. While the growing number and variety of instruments have led to greater complexity. Notes and Bonds Commercial Paper Certificates of Deposit (CDs) Options Swaps Common Stock Corporate Bonds and Notes Municipal Bonds and Notes Asset-Backed Securities Banker's Acceptances Mutual Funds Futures Currency Page 7 of 30 . we'll examine the investment instruments they use.S. investors can more easily tailor an investment program to their individual needs and risk tolerance. Treasury Bills.Investment Products: Professor Goodfellow: Now that you have a sense of the investment world's major players. Types of Investment Products Preferred Stocks Rights and Warrants U.

futures Pass Thrus. Most—but not all—second-generation instruments "build on" the traditional ones. that is shares of stock. That's why many of these instruments are called derivatives.. Products related to the futures market are a bit different. CMO's and Asset Backed Securities Stocks and bonds are also called capital market securities.. Futures trading is essentially a variation on the buyer-seller relationship. options. and rights are derived from or represent variations on the basic themes of stocks and bonds. Buying equity securities. Page 8 of 30 .Investment Products Traditional Products Equity securities (stocks) Debt securities (bonds) Second-generation Instruments Derivatives: warrants. displaced in time. Products like warrants. By buying debt securities—bonds—investors lend money to a business or government. rights. makes investors part-owners of a business. options.

You’ll get an overview of the different markets where securities are sold. Option: The right to buy or sell a security (or a more complicated version of these). the ways in which buyers can invest. Also known as a subscription warrant. the process of completing a transaction and the mechanisms in place to ensure a level playing field for all investors. . usually higher than the market price at the time of issuance. The Basic Processes The Markets Primary Secondary Methods of Investing Completing a Transaction (or "The Deal") Regulation Page 9 of 30 Harry Allen: The professor gave you some solid basics on the players and products in the investment world. that entitles the holder to buy a proportionate amount of common stock at a specified price.Warrant: Type of security. for a period of years or to perpetuity. usually issued together with a Bond or Preferred Stock. Right: The privilege granted to existing shareholders of a corporation to subscribe to shares of a new issue of common stock before it is offered to the public. Also known as a subscription right. Let’s have a look at the fundamental processes that these products go through from seller to buyer.

Products Warrants Bonds Stocks Rights Page 10 of 30 . they can be traded on the secondary market: On the various stock exchanges.The Basic Processes The Primary Market The Secondary Market People Brokers Investors Process Trading on the secondary market involves brokers and investors—but usually not the issuing organization. Once the "initial issues" have been sold on the primary market. where prices are determined by negotiation Both traditional and second-generation investment instruments are traded on the secondary market. where prices are determined by auction Over the counter.


 On Margin You can buy on credit-that is. risk-free securities which are converted to cash to settle the trade. and settlement to ensure a "level playing field" on which the various parties can conduct business with confidence.  Selling Short When you sell a security short. Buying on margin. To do this. or choose not to. the buyer and seller (and their representatives) must follow through and complete. You would keep the difference. trading. It is your hope that you will sell it today at a higher price and buy it back in the future at a lower price. all securities are paid for completely with either cash or highly liquid. Exchanging payment (on the one side) for the security (on the other side).The Basic Processes Methods of Investing Just as with any other type of purchase. buy low. there are different strategies and risks involved in each of these processes. . Selling short is where you hope the price of the security will fall. on margin. Completing a Transaction Once an actual purchase is made—regardless of method—the most visible aspect of a transaction is over. Sell high. or settle. you sell what you do not own. the transaction by: 1. there are several ways to invest in securities. Page 11 of 30  Cash In a cash account. you can try to take advantage of an expected increase in the item's price even if you can't. At this point. 2. you must borrow the stock today and buy it back at a future date. Recording the transaction. put out the total amount of cash required. Regulation Government and industry agencies regulate all aspects of issuing. Cash On Margin Selling Short Obviously.

Some of these terms have multiple meanings. yield is not something you do to let other drivers pass you by. the products and the processes in the Investment World. Let's now turn to our final overview of the investment world before we turn to the process by which a security is brought to the market. Now.Basic Terms and concepts: Professor Goodfellow: Alright then. it's the return on an investment. we'll run by you some of the basic terms and concepts that you will encounter again and again in the Fundamentals of the Securities Industry. now we've got a feel for the players. For example. .














This process of selling the new stock issues to prospective investors in the primary market is called underwriting. Close . governments. Distinguish between the primary and the secondary market. An organization that needs funds contacts their investment banker who typically assembles a syndicate of securities dealers that will sell the new stock issue. local authorities and international and supranational organizations (such as the World Bank) and in the case of many ABS Special Purpose Vehicles. currency exchange rates. Assignment Answers Who are the issuers of securities? Issuers of securities include commercial companies. options. swaps. floors. which is acting as an intermediary between buyers and sellers of securities in the secondary market where trading of securities that have already been issued in its initial private or public offering happens. The primary market is the financial market for the initial issue and placement of securities. futures. forwards and various combinations thereof. interest rates. Stock exchanges are examples of secondary markets. government agencies.Module Assignment Answers to the following questions: Who are the issuers of securities? What are derivatives? Distinguish between the primary and the secondary market. Securities dealers see this as the wholesale part of their business. What are derivatives? A derivative is a financial contract whose value is derived from the performance of assets. caps. The securites that they sell are called initial public offerings (IPOs). Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits. This is contrasted with the retail part of the business. Unlike in the secondary market. or indexes. collars. no organized stock exchanges are necessary.

Borrow money by issuing a bond? 2. We want to know what types of securities are issued and how they are issued. Sell stocks in the company by issuing shares of stock? 3.Raising Capital The Primary Market Let's examine how companies raise capital. Quality Copies is developing the technology to copy the whole human genome. Quality Copies. They see this as the wave of the future. Look into a merger or other form of business combination? 4. Here's where an Initial Public Offering (IPO) is born. Page 15 of 30 . But their product still requires a lot of expensive research and development— the final product will take a long time to get to market. When do they come to the market and who brings them to the market? But first let's take a look at a new company looking to raise capital. Borrow money directly from a bank or other lending institution? A bank loan may not be a viable option for QC. Narrator: A hot new company. now let's get to the reason we're all here. But it falls to the CEO to hit the street and raise the necessary capital. not just pieces of DNA. Remember Dolly the sheep? DNA cloning? Well. the next biotechnology revolution. How can Quality Copies come up with the R&D money it needs now? Should Quality Copies: 1. is striving to be a biotechnology leader. Page 14 of 30 Professor Goodfellow: Ok. This is gonna be HOT. We want to know how companies and governments raise capital: they do it by trading on the Primary Market.

A company might want to borrow money at a fixed rate for 20 years. individual investors are often willing to invest in risky situations if they feel the potential reward justifies the risk. Banks are often unable to lend to companies or government bodies with low credit ratings. 2. Banks are often unable to provide the terms that a borrower wants. there is some truth to the adage that "the only way to get a bank loan is to have so much money that you don't need one. whereas most banks will not make fixed-rate commercial loans with terms longer than seven years. For example. Not even a consortium of the largest banks could make a loan of this size.Why Bank Loans May Not Be Viable Options Unfortunately. 4. . Banks are often unable to lend potential borrowers the amount of money that they need to borrow. the United States' government has borrowed over $14 trillion. bank loans often prove to be inadequate for four main reasons: 1. New companies often don't have enough collateral to secure bank financing. Because banks have a duty to their depositors not to take excessive risks with their deposits." On the other hand. 3. Banks often charge borrowers higher interest rates than credit-worthy companies and governments have to pay if they raise capital directly from investors.

The process by which the stock is offered. The process of "going public" involves many steps: Choosing the Investment Banker Registration Statement Full Disclosure The Cooling-Off Period Distributing the Security Page 16 of 30 Initial Public Offering (IPO): The corporation is offering a new issue [class] of securities to the public for the first time.Raising Capital: The Process When a corporation first offers its stock for sale to the public. or issued. This is also known as an IPO—initial public offering. is called an underwriting. See also underwriting agreement. Investment banker: Firm acting as underwriter or agent that serves as intermediary between as issuer of securities and the investing public. it is said to be going public. Cooling-off period: A period during which the SEC examines the proposed registration documents for errors. There are two basic types of underwritings: firm and best efforts. . They differ primarily in the investment firm's level of commitment to the underwriting.

if a small. the investment banking firm matches it with investors who do not want any credit risk. it needs to sell stock to raise the money. are in contact with thousands of investors. the investment banker can match securities issuers with investors for whom the securities are appropriate. they help the company or organization to: 1.The Investment Banker Companies and governments often turn to an investment banker for help in raising capital. government. growth company wants to continue its promising research and development program. Structure the Securities Offering 3. On the other hand. For example. The investment bank matches the company with investors who are seeking high-risk/high-reward investments. An investment banker is usually a brokerage firm that serves as an intermediary between potential investors. The term underwriter is used to describe the investment banker's role in this procedure. and the companies and governments seeking to raise capital. Page 17 of 30 . Raise money In other words. if the issuer is the U. Identify opportunities to raise capital 2. through their brokers.S. Because such firms.

with attractive growth potential. Page 18 of 30 Syndicate: A short term partnership formed for the purpose of underwriting and selling a new issue of securities. The issuing company still gets its money from the sale. If the investment bank can't resell the securities. Negotiated versus Competitive Since Quality Copies is a pretty great idea. lots of investment firms will want to underwrite the offering. But what if it wasn't such a great company with such a great idea? What if only one investment bank was interested in underwriting? Then the firm would negotiate the price with that investment bank. This difference between the price the underwriter pays for the security and the price at which the underwriter sells it is called the Underwriter's Spread.Types of Underwritings Firm Underwritings This represents a very high commitment on the part of the investment banking firm. So Quality Copies gets to choose the underwriter that's willing to pay the most for its securities. . then they own them. The investment banking firm charges investors a slightly higher price than they paid the issuer in order to make a profit on the overall transaction. The syndicate actually buys the securities from the issuing company using the firm's own capital and then resells the securities (usually on the same day) to investors that the syndicate has lined up. This is Competitive Underwriting. And that's called Negotiated Underwriting.

acting as agents. and now they want to sell it on the market at a higher price. agree to do their best to sell an issue to the public. these agents have an option to buy and an authority to sell the securities. .The Process of a Public Offering The investment bank Acker Kern & Acker has agreed to be the lead manager of the syndicate underwriting the IPO for Quality Copies. nor their employees. If a new IPO is really super hot. . normally an issue of a small company's shares would be done on a "best-efforts" basis. But it's thought that Quality Copies' stock is going to shoot straight up on the first day of issuance and become what's called a "hot issue". The investment bank makes no guarantees as to how many shares it can sell or what price they will be sold for. where the investment bank does not buy the securities from the issuing firm. HOT ISSUES A hot issue is a new security offering that is very actively sought after by investors. by asking an investment banker to serve as an intermediary between potential investors and Quality Copies. neither the firms themselves.. Instead of buying the securities outright. Best Effort: An arrangement whereby investment bankers. but acts only as a sales agent. the market price of the newly issued securities quickly rises in the secondary market.nobody were interested in risking their capital on the little company with the risky idea? Then a company resorts to a "best efforts" underwriting. Page 19 of 30 Professor Goodfellow: Quality Copies has decided to raise the capital that it needs through the primary market. But Quality Copies got Acker Kern & Acker to issue the shares on a "firm basis". nor relatives of employees are allowed to buy any shares of a hot issue during the offering. This means that the underwriter has actually bought all the stock from Quality Copies at one price. They have listed a fair market price of $12. ensuring an immediate profit for the initial investors.. Now. To prevent investment firms from keeping these profits to themselves. where the investment bank simply makes its best effort to sell the shares.00 per share in the prospectus.

Various other federal and state laws also protect the investing public from being given false. When a corporate issuer sets out to offer its securities to the public. if they deem no changes are necessary. Quality Copies. . 4. The Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC). The names and addresses of the directors and other senior officials.) In its review. By accepting a registration. because the securities can't be sold to the public until the SEC accepts the registration statement. 6. With respect to underwriting. (This 20-day period is often called the cooling-off period. The names and addresses of persons owning 10% or more of any class of the issuer's stock. under the guidance of the investment banker and a full team of lawyers issues the full disclosure statement." Congress passed the Securities Act of 1933. 3. or being otherwise defrauded. it becomes accepted. 5. which is then said to be effective. To enforce the requirements of the 1933 Act. the SEC supervises the registration of new securities and makes sure that the important information about an investment is disclosed to the public.The Process of a Public Offering Full Disclosure Amid the aftershocks of the 1929 stock market "crash. the SEC neither approves nor disapproves of the securities. which reviews the statement to determine if full disclosure has been made. The name of the issuer. Nevertheless. nor does it pass judgment on the investment merit of the proposed offering. The SEC examines the statement. Page 20 of 30 Narrator: At that point. The location of the issuer's principal office. Offenders are subject to stiff fines and imprisonment. Information included in the registration statement 1. The names and addresses of the underwriters (if any). or misleading information. The name of the state or sovereign power under which the issuer is organized. and. it must first file a registration statement with the Securities and Exchange Commission. inaccurate. after twenty days. acceptance is crucial to an underwriting. and thus effective. 2. the SEC is saying only that all the legally required information is adequately disclosed and that the necessary supporting documents have been included. The SEC merely "accepts" or "rejects" the registration statement on the basis of whether it includes all of the information that the SEC feels potential investors require when considering the purchase of the securities.

as the case may be. naming them specifically when annual payments exceed $25. 24. 26. The amount of capital stock of each class included in this offer. 23. Any consideration paid to a promoter in the preceding two years. partnership agreement. and so on. 27. directors. Remuneration payable to the issuers directly.7. 30. 15.000. 14. 10. underwriters. . A copy of the law firm's written opinion attesting to the legality of the issue. A copy of the underwriting contract or agreement. 9. 29. A copy of the underlying agreement or indenture affecting any security offered or to be offered by the issuer. A statement of securities reserved for options outstanding. bylaws. A copy of the issuer's charter. A statement of the issuer's capitalization. A copy of all material contracts referred to in item 24. 25. The purposes to which the proceeds of this offering will be applied. 19. 12. with names and addresses of persons allotted 10% or more of these options. Full particulars of any dealings between the issuer and its officers. The dates and details of material contracts created outside the issuer's ordinary course of business within the preceding two years. senior officials. Certified financial statements of any issuer or business to be acquired with proceeds of this offering. 8. The quantities of securities owned by the directors. 20. 17. to be paid to the underwriters. 18. and so forth. The names and addresses of any vendors of property or goodwill to be acquired with the proceeds of this offering. The price range at which the public offering will be attempted. An itemized detail of expenses incurred by the issuer in connection with this offering. 11. and holders of 10% or more of its stock that transpired in the preceding two years. 22. trust agreement. The issuer's funded debt. Commissions. fees. 16. The net proceeds derived from any securities sold by the issuer in the preceding two years and pertinent details of those sales. and 10% or greater holders. 28. The general character of the issuer's business. 21. The names and addresses of counsel passing upon the legality of the issue. 13. The estimated net proceeds to be derived from the offering.


Page 22 of 30 .Understanding How an IPO Happens While the SEC reviews the registration statement. Let's see what they're up to. the corporation's officers and the investment bankers scurry to finalize the arrangements for implementing the public offering.

If investors want to "read something" about Quality Copies' proposed offering. Missing from the original prospectus (red herring): offering price the coupon or interest rate of the debt instrument (sometimes) list of the underwriters participating in the offering Page 23 of 30 . and if so. the red herring is missing various types of information. The investment bankers ask their clients if they might be interested in purchasing Quality Copies' IPO. However. AKA can send them the "red herring." This document summarizes the information contained in the main part of the registration statement filed with the SEC. AKA's sales team and bankers are working furiously to circle the stock and form a syndicate. for how much.Understanding How an IPO Happens Red Herring During the cooling off period.


Most firms don't attempt to sell an entire new offering by themselves (unless the offering is a small one). the firm's investment banking group builds a syndicate. they solicit help from other firms. Page 24 of 30 . All of the firms involved in selling a new offering. are referred to as a syndicate. acting as a group. Instead. The firm that puts the deal together is called the syndicate's lead manager.Understanding How an IPO Happens The Syndicate While the firm's brokers busily line up potential investors.

Obtaining state approval for a securities offering is called blue skying the issue. Page 26 of 30 .Understanding How an IPO Happens Blue Skying the Issue Narrator: At the same time. the SEC informs the investment banking firm that the offering has become effective. Page 25 of 30 Understanding How an IPO Happens The Distribution Assuming there are no problems with the registration statement. the firm's legal department submits the registration statement and other supporting documents to the state securities regulators in every state in which the securities will be offered. sometime after the cooling-off period.

There are several purposes for holding this meeting: to give all the interested parties an opportunity to hear the corporation's top management and their advisors discuss the issuing company.Understanding How an IPO Happens Due Diligence Meeting The lead manager holds a due diligence meeting with all the interested parties. and the offering's terms and conditions to give people an opportunity to ask any question concerning the distribution to prepare a final prospectus (a condensed version of the registration statement) Page 27 of 30 .

and the deal is said to have "broken syndicate. the date on which the stock may be sold. final prospectuses are printed and an effective date. Understanding How an IPO Happens Quality Copies will now have the capital that it sought and investors will be able to follow Quality Copies' stock quotations in the papers and on the news under the ticker symbol QC. a price is set. For Quality Copies. often called a tombstone. not all offerings sell out on their first day). that day is today and it's being listed on Nasdaq. Page 28 of 30 Professor Goodfellow: Finally. the syndicate is disbanded. Page 29 of 30 © 2011 New York Institute of Finance ." The stock may now be bought and sold freely on the secondary market. an American Over-the-Counter exchange. is set.Understanding How an IPO Happens IPO Launch After the offering is completely distributed (remember. Then an advertisement. is placed in the financial press for the day of issue.

But first. you may want to check out the module on Equity Securities. Page 30 of 30 . Next.Module Wrap Up Harry and I have tried to give you some good solid basics. Good luck. you must take your review quiz.