Chapter 6: Corporate Actions

Question 1

Bond income events predictability

Answer 1

• Income derived from interest payments is more predictable than dividends from equities.
• Bonds market price can rise if the IR rate falls after the bond is purchased
• Issuers of bonds also have the predictability as they know when they need to pay the coupon
• Floating rate notes are less predictable as the coupon is floating with a publish rate.
• The other issue with predicting bond income is when the issuer defaults.

Question 2

Equity income events predictability

Answer 2

• Dividend payments are hard to predict as they are based on a firm’s performance. However, large established firms will have more defined dates for paying dividends and will aim to deliver a consistent growth of dividends to satisfy shareholders.
• The upside of a large dividend payment is a huge upside for investors
• Issuer benefit - can reduce or stop paying dividends if they need to preserve cash, unlike bonds where coupons are mandatory
• preference shares have predefined dividend payment dates and amounts increasing the predictability of income. Issuers can also reduce or not pay dividends

Question 3

Capital events - bond repayments
- bullet and non bullet issues

Answer 3

= repayment of the borrowed principal amount

• bullet payment in the UK and US when the principal is paid to the lender in 1 go.
• non bullet - repay the lender over a series of payments

Bullet issuers are considered to be riskier (pay more interest) than non bullet as it requires a large sum of money to be paid all in 1 go at a future date

Question 4

Sinking fund

Answer 4

Variation of bullet maturity where the issuer of the debt sets aside funds each year to slowly accumilate ready to pay off the principal. The funds are often held in trust by a seperate entity.

Reduce the issuer credit risk.

Question 5

Callable and puttable bonds

Answer 5

Callable= issuer has the right but not the obligation at specified points in a bonds life to redeem some or all of the issued bonds at the pre-agreed par value.

Putable = allow bond holders/investors to redeem the principal early.

Question 6

3 types of equity capital event (corporate action)

Answer 6

1. Bonus issue
2. stock split
3. reverse stock split

Question 7

Bonus issue - 3 types of bonus issue

Answer 7

Issue more shares with no consideration (pro bono) for raising more capital. Usually used to dilute the number of shares on offer and lower the share price to make it more attractive. Shares rank equally in repayment seniority (pari passu).

3 types of bonus issue
1. Bonus issue
2. scrip issue
3. capitalisation issue

The earnings per share will be lower as there are more shares and more shareholders to distribute dividends between. Share mkt price should fall proportionally too, leaving mkt cap. unchanged.

Question 8

Stock splits (AKA subdivision)

Answer 8

= Each share is split into a number of shares.

This is done when a share price is considered too high, affecting investor access.
* Dividends paid on each share are split in accordance with the split (e.g. 5 to 1 split)
* Impact on the accounts = doesn’t alter the share capital line of the accounts - same number of shares just subdivided into a larger number of shares.

Question 9

Reverse stock split - AKA consolidation

Answer 9

= Shares are combined or consolidated. ie 10 shares trading at 10p are combiined to create 1 share of £1. This is done if the share price is too low and the corp wants to make it more marketable.

Impact on company accounts = similar to a stock split - no change to accounts - same number of shares just subdivided into less shares with a larger nominal.

Question 10

Impact of capital restructuring on share price

Answer 10

EXAMPLES ON PAGES 185-190

Question 11

Pre emptive rights - impact on rights issues

Answer 11

Pre emptive rights give exisiting shareholders the right to subscribe to more shares before the offering is made to the public. This prevents dilution of voting rights. This is legally enforced in most countries.

Prevents corps from issuing new shares, warrants or convertible bonds without offering them to shareholders first. This can be overturned by a special resolution agreed by shareholders at AGMs.

Question 12

Rights issues and why they are attractive

Answer 12

= Offers new shares to exisiting shareholders in proportion to their exisiting holding in the company at a discounted price to that issued to the public.

Attractive because:
* No dilution of exisiting shareholders voting rights
* The issue to shareholders is at discount to mkt price
* Shareholders that do not want to subscribe to the rights issue can sell their rights for cash.
* Issues are underwritten to account for the shareholders who don’t want to excercising their rights
* Shareholders are given a provisional allottment letter with the number of shares set aside for them. This letter can be sold if they don’t want to exercise their right to the issue.

Bottom line - issues new shares without diluting shareholders

Question 13

Mechanics of a rights issue definitions

Answer 13

• Cum rights - exisiting shareholders
• Ex-rights - new share holders to be when the issue is made public.

1. Cum-rights are given the right to subscribe to their allotted shares usually the day after the rights issue is announced. They are given a provisional allottment letter which is renouncable and transferable
2. The ex-rights period begins the day after these letters are posted which will see the share price fall to the diluted market price.

Question 14

Ex-rights price calculation - IMPORTANT

Answer 14

**[(no shares held cum-rights X Cum-rights share price) + (No rights allocated X rights issue price)]
_______________________________________________________________________
Total no. shares held assuming rights are exercise.

Question 15

Choices for exisiting shareholders in a rights issue - how to react to issue.

Answer 15

1. Take up the rights in full - holder wants to buy all shares offered - returns the provisional allotment letter back to the issuer with a cheque to buy the shares
2. Sell the rights nil-paid in full - Shareholder signs the renunciation on the prov. allottment letter and sells the letter on the market at discount. This is essential a sort dated call option.
3. sell part of the rights nil-paid to preserve current holding without dilution - sells some shares to finance buying the new shares. A broker splits the prov. allottement letter to be sold and retained respectively.
4. Take no action - no action = shares sold nil-paid. The proceeds of the sale a distributed pro rata to shareholders.

Question 16

Rights issue example of PAGE 195 - READ TO UNDERSTAND

Question 17

Nil-Paid value - calculation and meaning

Answer 17

Ex-rights price - rights issue price

Compaes the theoretical ex-rights price to the actual price of exercising the right.

Page 197

Question 18

Selling rights to take up others (swallowing the tail)

Answer 18

= Investors sell some rights to provide capital to buy the remaining rights to prevent dilution. No additional capital is invested by teh shareholder.

This leaves the investor in the exact same holding as they were before the issue.

Question 19

Calcultion for the no.nil-paid shares to be sold to take up the rest of the issue to prevent dilution

Answer 19

Issue price of new shares X Number of shares allocated
_________________________________________________
Theoretical ex-rights price

This will show how many shares need to be sold in order to generate enough capital to buy shares to keep the stake in the corp. the same.

Question 20

Share buybacks - what are they, 2 reasons why to do them, regulation - creditors buffer

Answer 20

= When corps use cash to buy shares back off exisiting shareholders. Main reasons are:
1. Corp has surplus cash from e.g. selling part of it’s business.
2. Corp wants to reorganise its capital structure to include more debt. The corp will issue bonds to finance buying back equity.

This is regulated in the UK setting a limit value of shares rebought in a year. There are accounting tests the corp must pass before buying back shares - called the creditor’s buffer. Shareholders must also approve this at an AGM.

Question 21

Methods of performing a share buy back

Answer 21

1. Block trades - an IB working with the corp will arrange a small number of large trades, potentially via an exchange.
2. Accelerated book build - IBs contact shareholders and offer them a price to sell their shares. If the buy-back is big enough a syndicate of brokers will be required and they will buy shares back at or below a maximum price (back stop price). A best efforts approach means there is no promise of achieveing the back stop price or buying the number of shares they said they would.
3. bought deal - an underwriter buys all of the shares back and attempts to resell them to clients.

Question 22

Stakebuilding and the use of CFDs

Answer 22

Strategic stakes are accumilated buy the firm itself or another firm buying shares in the target to:
* prevent a company from being taken over
* retain majority voting rights
* take over another company.

A more secretive way to stakebuild if the aim is to acquire a corp is using contracts for difference (CFDs). CFD is an agreement between buyer and the seller to exchange the difference in price of a share at the end of the contract (e.g. share price goes up=seller pays the buyer and visa versa). This is + because it allows the potential predator to hold a secretive stake in a firm that is less visible and can be leveraged as the contracts are sold at a lower value than that of the price of the shares. Stamp duty exempt

The UK has regulations on stakebuilding - requiring disclosure once a holding exceeds 3%.

Question 23

Mergers and acquisitions

Answer 23

Takeover/acquisition = a predator buys greater than 50% of the shares in a target corp. Friendly takeovers are when directors are happy with the takeover and recommend shareholders accept the offer. Hostile takeovers are when directors recommend shareholders reject the offer for a takeover.

Merger = 2 similar sized corps come together to make one big entity. The 2 corps normally exchanges shares in their respective firms.

Question 24

Panel of Takeovers and Mergers (POTAM) mandatory requirements for cash offers if a company is buying another

Answer 24

When a cash offer is required it must not be less than the highest price paid by the offeror in the previous 12 months

Question 25

Swallowing the tail calc

Answer 25

Quantity X exercise price /ex rights price