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| wealthy individuals who invest their own money in new ventures |
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| underwriting agreement in which the underwriter does not agree to purchase the securities at a particular price but promises only to make its “best effort” to sell as much of the issue as possible above a certain price |
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| the process by which many entrepreneurs raise seed money and obtain other resources necessary to start their businesses |
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| firm-commitment underwriting |
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| underwriting agreement in which the underwriter purchases securities for a specified price and resells them |
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| a sale of debt or equity, open to all investors, by a company that has previously sold stock to the public |
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| the initial registration statement filed with the SEC by a company preparing to issue securities in the public market; it contains detailed information about the issuer and the proposed issue |
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| the sale of securities to the public by a firm that already has publicly traded securities outstanding |
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| a type of SEC registration that allows firms to register to sell securities over a two-year period and, during that time, take the securities “off the shelf” and sell them as needed |
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| a business loan with a maturity greater than one year |
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| offering new securities for sale at a price below their true value |
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| a group of underwriters that joins forces to reduce underwriting risk |
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| individuals or firms that invest by purchasing equity in new businesses and often provide entrepreneurs with business advice |
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| Which one of the following statements is NOT true? |
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XX Bootstrapping and venture capital financing are not part of the private market.
Many private companies that are owned by entrepreneurs, families, or family foundations and are sizable companies of high credit quality prefer to sell their securities in the private markets.
Bootstrapping and venture capital financing are part of the private market.
For many smaller firms and firms of lower credit standing that have limited access, or no access, to the public markets, the cheapest source of external funding is often the private markets. |
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| Which one of the following statements is NOT true? |
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XX Private equity firms invest in new companies.
Private equity firms invest in more mature companies.
Private equity firms pool money from wealthy investors, pension funds, insurance companies, and other sources to make investments.
Private equity investors focus on firms that have stable cash flows because they use a lot of debt to finance their acquisitions. |
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IPO pricing: Stump, Inc., a technology firm in Prairie View, Texas, issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day.
What is the underpricing spread? |
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Underwriter’s gross spread ($22 – $17) =$5 per share.
Number of shares outstanding = ($66 million/$22 per share) = 3 million.
Underwriting cost = ($5 per share x 3.0 million shares) = $15.0 million |
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IPO pricing: Stump, Inc., a technology firm in Prairie View, Texas, issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day.
What is the underpricing on this issue? |
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Stock price at end of first day = $22(1.15) = $25.30
First-day underpricing = ($25.30 - $22) = $3.30 per share.
Total underpricing = ($3.30 per share x 3,000,000 shares of stock) = $9,900,000 |
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IPO pricing: Stump, Inc., a technology firm in Prairie View, Texas, issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15 percent on the first day.
What is the firm's total cost of issuing the securities? |
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| Total cost to the firm of selling the IPO = $15,000,000 + $350,000 + $9,900,000 = $25,250,000 |
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| General cash offering: Star Corporation, an auto fuel cell maker, is planning a new plant and needs to raise $30 million to finance it. The company plans to raise the money through a general cash offering priced at $23.50 a share. Star's underwriters charge a 6 percent spread. How many shares does the company have to sell to achieve its goal? |
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Underwriter’s spread = 6 %
Price per share the firm gets = [$23.50*(1 – 0.06)] = $22.09
Therefore, to raise $30 million, the company needs to issue:
$30,000,000 / $22.09 = 1,358,081 new shares |
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| Bank lending: Suppose two firms want to borrow money from a bank for a period of 10 years. Firm A has excellent credit and can borrow at the prime rate, whereas Firm B's credit standing is prime + 2. The current prime rate is 5.75 percent, the 30-year Treasury bond yield is 4.35 percent, the three-month Treasury bill yield is 3.54 percent, and the 10-year Treasury note yield is 4.24 percent. What are the appropriate loan rates for each customer? |
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Prime rate =PR = 5.75%;
Maturity risk premium = MAT = k10-year kT-bill = 4.24% - 3.54% = 0.70%
Borrowing rate for firm A = k = Prime rate + MAT
= 5.75% + 0.70% = 6.45%
Borrowing rate for firm B = k = Prime rate + 2% + MAT
= 5.75% + 2% + 0.70% = 8.45% |
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| The most likely reason that underpricing of new issues occurs more frequently than overpricing is the: |
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Demand for a new issue is typically too high.
Underwriters earn low rates of return.
Issuing firms demand that equity be underpriced.
XX Underwriters’ desire to reduce the risk of a firm commitment. |
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| A firm is making an initial public offering. The investment bankers agree to a firm underwriting commitment of 500,000 shares priced to the public at $50 a share. The underwriter’s spread is 12%. In addition, the underwriter charges $600,000 in legal fees. On the first day of trading, the firm’s stock closed at $61. What were the total costs of the issue? |
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Stock price at end of first day = $61.00
First-day underpricing = ($61.00 – $50.00) = $11.00 per share.
Total underpricing = ($11.00 per share x 500,000 shares of stock) = $5,500,000
Underwriter's gross spread ($50.00 x .12) =$6.00 per share.
Underwriting cost = ($6.00 per share x 500,000 shares) = $3 million
Total cost to the firm of selling the IPO = $3,000,000 + $600,000 + $5,500,000
IPO = $9,100,000 |
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| Why is the total cost of bringing a general cash offer to the market lower than issuing an IPO? |
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They do not include a large underpricing
Underwriting spreads are smaller
There is less risk involved with a general cash offer than an IPO
XX All of these |
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