Types of Issuers:

• Issuers are legal entities that raise capital by securities. These include:
  • Corporations (Apple, Microsoft)
  • US Treasury & Government Agencies (Fannie Mae, Freddie Mac)
  • State & Local Governments (Municipals) 
  • Banks (They can raise & issue, and help others buy & sell securities)
  • Foreign Governments 
• Types of securities that may be issued:
  • Equity – used by corporations
    • Represents ownership
    • Dividends can be offered
  • Debt – notes and bonds
    • Represents an issuer’s promise to pay
    • Bond holders are creditors (receive interest)
    • Ownership is not diluted
• Can be issued publicly or privately. Corporations and Banks are the main issuers.

Broker-Dealers Function:

• Broker:
  • Firm acts as a conduit or agent
  • Finds another party willing to take the other side of the trade
  • Collects commission for the service
  • No risk to the firm
• Dealer:
  • Firm acts as a principal
  • Firm takes the other side of the trade
  • Entitled to markup/markdown
    • Markup: When client is buying & firm is selling (they’ll charge higher price)
    • Markdown: If broker firm is acting as a dealer and buying securities from seller, they’ll buy at a lower price
  • Inventory / risk

The Structure of a Securities Firm:

• Issuer
  • Investment banking
    • Issuance
    • M&A
    • Private equity
    • Debt & Equity Capital Markets
• Investors
  • Research
  • Private client
    • Retail brokerage
  • Sales & trading
    • Fixed income
    • Equity 
  • Investment management 
• Information Barriers: The Chinese Wall
  • Certain information should not be discussed in other areas of the firm
  • If IB is working on M&A, they don’t want other departments in the firm to know about it because they’ll trade it in advance

Market Maker and its Quote:

• A market maker is a broker-dealer that chooses to display quotes to buy or sell a specific amount of securities at specific prices
  • Quotes are firm (obligated to buy/sell) for at least 100 shares
  • 100 shares means round lot / 1000 shares is 10 round lots
  • If you buy in units of 50, 25, 18 this is referred to as an odd lot
• Generally applies for equity securities, not debt
• Maintain an inventory of securities

Bid:

• Represents a client’s selling (liquidation) price
• This is the price at which the Market Maker will buy

Ask (Offer): 

• Represents a client’s purchase price
• This is the price at which the Market Maker will sell 

Differential between the Bid and the Ask is the spread

• The wider the spread, the more the market maker makes
• The narrower the spread, the less the market maker makes
• More actively traded securities have a narrower spread, and vice versa

Market Makers make spread, dealers mark up/down, agents make commission

Investment Adviser (IA):

• An IA is a firm that charges customers a fee for managing their securities portfolios
  • The fee is based on the assets under management (AUM)
  • An IA is considered a large or institutional customer of a broker-dealer 

Municipal Advisors (MA):

• An MA is a person or firm who advises municipalities on bond offerings and must be registered with the SEC
  • Typically advise issuers (state, country, or city) regarding the structure and timing of a new offering 

Institutional Investors:

• Investors are typically defined based on the amount of assets they have invested
• Customers with a large amount of assets are referred to as “institutional investors,” such as:
  • Banks
  • Insurance companies
  • Investment companies
  • Corporations, partnerships, individual investors with a certain amount of money invested
  • Registered investment advisers
  • Public & private pension plans
  • Hedge funds

Retail Investor:

• Individual investors who are not defined as institutional investors are considered “retail investors”

Accredited Investors:

• There are other terms used for certain investors, but they are based on regulatory definitions
• Accredited investors are institutional investors as well as individuals who have met a financial test:
  • Net worth of $1M, excluding primary residence OR
  • Annual income of $200,000 in each of the last 2 years ($300,000 married couples)

Qualified Institutional Buyers (QIBs):

• Buyer must own and invest a minimum of $100 million of securities
• Cannot be a natural person (human)

Primary Market:

• New issue market
• Regulated by 1933 Securities Act
• Investment bankers to help corporations issue securities to raise money

Issuer

• Needs Capital
• Hires Underwriter

Underwriter:

• Buying securities from issuer and reselling to investors
• Facilitates distribution
• Assumes liability that varies with offering type
• Signs Underwriting Agreement with issuer

Investor:

IPO v. Follow-On: Equity Markets only

• If company goes public for the first time, this is called an Initial Public Offering (IPO)
• If a company like TSLA does an IPO, and later on, they need to raise more money to build a battery plant, they can sell another equity stake of their company. If an existing company sells equity securities at a future point in time after the IPO date, this is called a follow-on (you can have multiple follow-ons)

Secondary Market:

• Once issued, the security is traded on the secondary market
• Trading markets that facilitate the exchange of existing financial instruments among investors
• Regulated by 1934 Securities Exchange Act
• Normally monitored by a specialist or designated market maker (DMM)
• If I buy 100 shares of IDM, my money doesn’t go to IDM, it goes to another investor
• Can be on the NYSE, NASDAQ, or OTC
  • OTC BB (Bulletin Board) 
  • Pink markets (Quotes for unlisted stocks)

Dealer-to-Dealer Markets:

• NASDAQ
  • Non-physical phone and computer network
  • Negotiated market
  • Unlimited number of registered “market makers”
  • Classified as a securities exchange 
• Non-Exchange Issues (OTC)
  • Often low priced and thinly traded
  • A system that offers real-time quotations:
    • OTC Pink Markets
      • May be reporting or non-reporting companies
• Market Makers
  • Stand ready to buy or sell at least 100 shares at their quoted prices
  • Subject to SRO (Self-Regulatory Organization) rules
• Traders / Agency Traders
  • Execute trades for their firm of their firms’ clients
  • Don’t maintain an inventory

Other Secondary Market Terms:

• Third Market
  • Listed securities traded OTC
  • Trades included in NYSE volume totals
• Fourth Market
  • Transactions between institutions (bank buys from pension fund)
  • Most true fourth market trades are internal crosses set up by money managers
• Dark Pools
  • Provides liquidity for large institutional investors and high-frequency traders
  • Quotes are not disseminated to the public (it’s anonymous)
  • Limits impact on the market

Clearing & Settlement: 51:00 min time frame 

• DTCC
  • NSCC (Equities), FICC (Fixed Income)

Clearing Firms

→ Introducing (Correspondent) Firms

• Omnibus
• Fully Disclosed

Fully Disclosed v. Omnibus:

• Introducing firms process trades through clearing firms in one of two ways:
• Fully Disclosed Accounts
  • Specific information about each individual client is given to the clearing firm
  • Clearing firm is responsible for:
    • Maintaining client assets
    • Establishing a separate account for each client
    • Sending confirmations, statements, and checks
      • Contact information for introducing firm is included
• OmnibusAccounts
  • A single account is set up at the clearing firm
  • Specific client information is maintained by the introducing firm
  • Recordkeeping responsibilities rest with the introduction firm 

Who keeps the books and records:

• If fully disclosed, clearing firm does
• If omnibus accounts, the introducing firm does 

DTCC and the OCC:

• Depository Trust & Clearing Corp.
  • Provides clearing,fes for its members
    • Is parent of the National Securities Clearing Corporation (NSCC)
  • Guarantees settlement
  • Removes counterparty risk
  • Transactions among members are completed through computerized bookkeeping entries
• Options Clearing Corp.
  • Issues and guarantees options contracts
  • Regulates exchange-traded options (listed options)
    • Acts as the third party in all options transactions (the buyer for all sellers and the seller for all buyers)
  • Deals directly with broker-dealers, not customers
  • Trade settlement between broker-dealers and the OCC is next business day

Prime Brokerage Accounts:

• When a primary B/D provides a large client (ex: hedge fund) with the ability to clear all trades through a centralized firm with executions occurring with multiple B/Ds
  • Prevents a single firm from determining the client’s strategy
• The prime broker offers specialized services such as custody, securities lending, margin financing, clearing, processing, operational support, research, and customized reporting