Equity & Debt Financing

Question 1

What is the process of a public offering?

Answer 1

Management gets the approval of the Board, discussions with underwriters, registration statements filed, pricing the issue, public offering and sale, and market stabilization

Question 2

What is a public issue?

Answer 2

The shares will be traded on a stock exchange and the firm is required to register the issue with the stock exchange on which it is listed

Question 3

What is a private issue?

Answer 3

If the issue is sold to only a few institutions

Question 4

What are the two different kinds of public issues?

Answer 4

The general cash offer (to all investors) or the rights offer (sold to existing shareholders)

Question 5

What is equity sold by?

Answer 5

Both the cash offer and the rights offer, although almost all debt is sold by cash offer

Question 6

What is a first public equity issue called?

Answer 6

An Initial Public Offering (IPO)

Question 7

Is IPO positively or negatively related to the performance of stock markets?

Answer 7

Positively, and this has been reflected in the slew of new issues in Europe and the uS over the last few years

Question 8

Why might it be difficult to price an IPO?

Answer 8

Because there is not a current market price available

Question 9

What do underwriters want to ensure?

Answer 9

That, on average, their clients earn a good return on IPOs

Question 10

What does underpricing cause?

Answer 10

The issuer to “leave money on the table”

Question 11

What are all the cost of new issues?

Answer 11

Spread or underwriting discount (payment to the underwriter), other direct expenses (filing fees, legal fees, taxes), indirect expenses (e.g. management time), abnormal returns (share price drop as a result of a new issue), underpricing (IPOs), and the Green Shoe Option (option for underwriter to buy extra shares at offer prices)

Question 12

What happens if a pre-emptive right is contained in the firm’s articles of incorporation?

Answer 12

The firm must offer any new issue of common stock first to existing shareholders, which allows them to maintain their percentage ownership if they so desire

Question 13

What must the management of the firm decide?

Answer 13

The exercise price (the price existing shareholders must pay for new shares), and how many rights will be required to purchase one new shoe of stock

Question 14

What is the subscription price?

Answer 14

The price that existing shareholders are allowed to pay for a share of equity

Question 15

What will a rational shareholder do?

Answer 15

Subscribe to the rights offering only if the subscription price is below the market price of the equity on the offer’s expiration date

Question 16

What happens with shareholders when exercising or selling rights?

Answer 16

Nothing, they can neither lose nor gain from it

Question 17

What are the different types of financing?

Answer 17

Seed, start-up, growth, mezzanine finance, and buyout

Question 18

What are the different types of long-term debt?

Answer 18

Corporate debt (can be short- or long-term), public debt (bonds), or private (loans)

Question 19

What are the differences from common stock?

Answer 19

Creditor’s claim on corporation is specified, promised cash flows, and most are callable

Question 20

What are over half of the outstanding bonds owned by?

Answer 20

Life assurance companies and pension funds

Question 21

What are the features of a bond?

Answer 21

Amount of issue, date of issue, maturity, face value, annual coupon, offer price, coupon payment dates, security, sinking fund, call provision, call price, and rating

Question 22

What is an indenture?

Answer 22

A written agreement between the borrower and a trust company (is specific to bonds)

Question 23

What does an indenture usually list?

Answer 23

Amount of issue, date of issue, maturity, denomination, annual coupon, dates of coupon payments, security, sinking funds, call provisions, and covenants

Question 24

What are protective covenants?

Answer 24

Agreements to protect bondholders

Question 25

What does a negative covenant entail?

Answer 25

Thou shalt not: pay dividends beyond a specified amount, sell more senior debt and amount of new debt is limited, refund existing bond issue with new bonds paying lower interest rate, and buy another company’s bonds

Question 26

What does a positive covenant entail?

Answer 26

Thou shalt: use proceeds from sale of assets for other assets, allow redemption in event of merger or spinoff, maintain good condition of assets, and provide audited financial information

Question 27

What is a sinking fund?

Answer 27

An account with the bond trustee; each year company makes payments into it, and trustee uses it to redeem some bonds

Question 28

What do sinking funds provide?

Answer 28

Extra protection to bondholders and provide the firm with an option to buy bonds back at the lowest possible price

Question 29

What happens when interest rates go up?

Answer 29

Bond value goes down

Question 30

What happens when interest rates go down?

Answer 30

Bond value increases

Question 31

Should firms issue callable bonds?

Answer 31

It gives the issuer possibility to replace the bonds with a cheaper issue if the interest rates go down, this provision reduces the value of the bonds for the bondholders

Question 32

What are reasons to issue callable bonds?

Answer 32

Insider information on interest rates/potential rating changes, tax savings from the higher coupon rate, financial flexibility (avoiding restrictive covenants), and less interest rate risk

Question 33

When to call bonds?

Answer 33

Call when the bond value = call price + refinancing costs

Question 34

In regards to bonds, what is rated?

Answer 34

The likelihood that the firm will default, and the protection afforded by the loan contract in the event of default

Question 35

In regards to bonds, who pays for the ratings?

Answer 35

Firms pay to have their bonds rated, and the ratings are constructed from the financial statements supplied by the firm

Question 36

What is a junk bond?

Answer 36

A high-yielding high-risk security, typically issued by a company seeking to raise capital quickly in order to finance a takeover

Question 37

What are the two types of junk bonds?

Answer 37

Original issue junk (possibly not rated), and fallen angels (rated)

Question 38

What are junk bonds frequently used for?

Answer 38

To finance mergers and acquisitions