4 The New Issues Market and Types of Securities

Question 1

What is the primary market?

Answer 1

The Primary market, also known as the new issues market, is where new securities are issued for cash, thus enabling companies to raise new capital

Question 2

What is the secondary market?

Answer 2

The secondary market, known as the trading market, is where previously issued stocks are exchanged for cash

Question 3

What is an IPO?

Answer 3

The first time stocks are offered for public sale

Question 4

What does an underwriter do?

Answer 4

Underwriters offer:
o procedural and financial advice,
o Then they buy the issue,
o Finally, they resell it to the public
Often they will do a roadshow to larger institutional investors to gauge the market and secure orders

Question 5

Why do underwriters form syndicates?

Answer 5

To reduce risk

Question 6

Why do underwriters not want to price an IPO too high?

Answer 6

As they will be left with a lot of stocks on their books

Question 7

Why do managers want a high IPO price?

Answer 7

As it will generate more funds

Question 8

How do underwriters make money?

Answer 8

From the spread of which they buy and sell them for

Question 9

What is the winner’s curse when pricing an IPO?

Answer 9

When you are bidding on something and win an auction everyone else will think you have overpaid or they would have bid further. This acts against the general assumption that IPOs are underpriced, especially on attractive opportunities with lots of bidders

Question 10

What are the types of new issue?

Answer 10

• Restricted invitation
• Public invitation
• To existing shareholders

Question 11

What is a restricted invitation IPO?

Answer 11

When placings are made to the clients and connections of the company’s broker or issuing house.

Question 12

What type of security is suited to a restricted invitation?

Answer 12

Debentures

Question 13

What is involved in a public invitation?

Answer 13

• A prospectus has to be prepared
• Advertising, setting out the attractions and the availability of the company’s shares
• The companies act and rules of the stock exchange impose strict requirements on the preparation of the prospectus
• Requires expert opinion of an issuing house, auditors, valuers etc.
• Issue by public invitation is costly.

Question 14

What are the three ways the public might be invited to lend money to a company?

Answer 14

1. Direct invitation
2. Offer for sale
3. Offer by tender

Question 15

What are the key issues for direct invitation and offer for sale?

Answer 15

• There is a great importance on price setting
• The is a danger of miss pricing the security

Question 16

What is an offer by tender?

Answer 16

• The company sets a reserve price
• The keen buyer will bid high, not so keen buyer will bid low, and the share price is determined by the highest price at which shares are taken up

Question 17

How do offers to existing shareholders work?

Answer 17

• Such an offer is known as a Rights Issue
• Specified number of new shares in proportion to the number already held

Question 18

Why are offers to existing shareholders discounted?

Answer 18

• It looks like the stock is massively discounted when they are offered
• But the markets are considered efficient
• Therefore the market will adjust for the new issue as seen bellow

Question 19

How do you find the price of rights?

Answer 19

If you had to find the ex-rights price:
=(Value of the Company)/(No of shares)
If you had to find the value of the right:
=(Theoretical ex rights price -subscription price)/(No of shares required to purchase 1 new share)

Question 20

Example IPO questions

Answer 20

Look on lecture notes