Tuesday, July 14, 2009

primary financial markets

The issuance of stocks and bonds in the primary securities market is aided by so-called investment bankers (who often also act as brokers and dealers in secondary markets). An investment banker undertakes what is called an underwriting of a new issue. Underwriting means that the investment banker normally guarantees to the issuing corporations and governments a fixed price and (in the case of a bond) a fixed yield. The underwriting investment banker publicly announces the upcoming new issue in financial publications and elsewhere.
Underwriters will attempt to sell the underwritten stocks or bonds within a day or so of the date of issuance. The investment bankers underwriting the new issues in the primary securities market earn their profit by attempting to "buy cheap and sell dear." they attempt to sell the new issues at a price higher than the price they have guaranteed to the issuer. Note, however, that investment bankers are not true bankers, and they do not carry out investment spending. Rather, they are simply market makers in the sense that they make sure a market exists for about-to-be-issued new securities. Investment bankers do not accept deposits, nor do they make commercial or consumer loans. In fact, commercial bankers were prohibited from underwriting corporate securities by the Glass-Steagall Act of 1933, which separated commercial banking and investment banking. commercial banks can do participate in underwriting the bonds of state and municipal governments, because their securities are presumed to be relatively safe-even though at times the governments of NEW YORK city,Cleveland,Boston,and the state of Michigan were more or less teetering on the brink of bankruptcy. Virtually all types of individuals, households, and businesses buy new issues. Some of the assets owned by financial intermediaries, for example, will have been purchased in the primary securities market.
The actual marketplace for the underwriting of new securities is the conference suites of investment banking firms, which are linked by telephone with each other and with the corporations or governments that are issuing the new securities. The investors (for example, large insurance companies and pension plan) will also be in communication via telephone with the underwriting investment banking firms. By far the most important commodity sold by investment banking firms is information about the yield required to sell an issue and the identity of prospective buyers.
Investment bankers are able to underwriting new issues not because they have acquired funds from deposits, but rather because they have enough of their own capital to buy up what is not sold to buyers at the guaranteed price. Consider an example: the big investment Banking firm underwrites XYZ Corporation is issuance of 1000 bonds with a face value of $10,000 offering a coupon rate of 10 percentage per year for 10 years. The big Investment Banking firm guarantees that the bonds will sell for at least their face value of $10,000 apiece. As it turns out, the bonds can only be sold at a discount. The average price is $9,000. The big investment Banking firm will incur a loss of $ 1,000 on each bond, for a total loss of $1,000,000.

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