Equity Financing in Capital Structure Flashcards
Initial Public Offering
IPO’s advantages
1) Greater liquidity
2) Better access to capital
Initial Public Offering
IPO’s disadvantages
1) Dispersed equity holdings
2) Compliance is costly and time consuming
What are the three mechanisms to sell stocks of share s?
1) Best efforts ( small IPOs)
2) Firm Commitment : most common
3) Auction IPOs ( directly to public)
Name all four steps to IPO
1) Underwriters manage the IPO
2) Companies must file registration statement
3) Valuation of the company
4) Underwriting spread ( rabais pour underwriters for first commitment )
What is over-allotment or greenshoe provision
additional share- like short
Which of the following statements is/are true?
I) The shares sold in a primary offering are existing shares that are sold by current shareholders.
II) For smaller IPOs, the underwriter commonly accepts the deal on a firm commitment IPO basis.
III) In a best-efforts IPO, the underwriter guarantees that it will sell all of the stock at the offer price.
A
I only
B
II only
C
III only
D
II and III only
E None of (A), (B), (C), and (D) are correct
E None of (A), (B), (C), and (D) are correct
Statement I is false.
The shares sold in a primary offering are new shares that are issued to raise new capital. The existing shares that are sold by current shareholders (as part of their exit strategy) is known as a secondary offering.
Statement II is false.
For smaller IPOs, the underwriter commonly accepts the deal on a best-efforts IPO basis. The underwriter does not guarantee that the stock will be sold but instead tries to sell the stock for the best possible price.
Statement III is false.
In a firm commitment IPO, the underwriter guarantees that it will sell all of the stock at the offer price. The underwriter purchases the entire issue at a slightly lower price than the offer price and then resells it at the offer price. If the entire issue does not sell out, the underwriter is on the hook.
In a best-efforts IPO, the underwriter does not guarantee that the stock will be sold but instead tries to sell the stock for the best possible price.
What is the difference between primary and secondary offering?
The shares sold in a primary offering are new shares that are issued to raise new capital. The existing shares that are sold by current shareholders (as part of their exit strategy) is known as a secondary offering.
What is best efforts IPO?
For smaller IPOs, the underwriter commonly accepts the deal on a best-efforts IPO basis. The underwriter does not guarantee that the stock will be sold but instead tries to sell the stock for the best possible price.
What is first commitment IPO?
In a firm commitment IPO, the underwriter guarantees that it will sell all of the stock at the offer price. The underwriter purchases the entire issue at a slightly lower price than the offer price and then resells it at the offer price. If the entire issue does not sell out, the underwriter is on the hook.
Which of the following statements regarding the valuation in a traditional IPO process is/are true?
I) The only way to set the initial price range for the offer price is by estimating the present value of future cash flows.
II) Once an initial price range is set, the underwriters try to determine what the market thinks of the valuation by using a greenshoe provision.
III) The underwriters undergo a process called book building where they adjust the share price to customer demand so that the IPO is most likely to succeed.
A
I only
B
II only
C
III only
D
I, II, and III
E None of (A), (B), (C), and (D) are correct
C
III only
Statement I is false.
Before the offer price is set, the underwriters work with the company to establish a price range that provides a reasonable valuation for the company using the following techniques:
Estimating the present value of future cash flows, or
Estimating the value of comparable companies.
Most underwriters use both techniques. However, when these techniques yield substantially different answers, the underwriters often rely on comparables based on the recent IPOs.
Statement II is false.
Once an initial price range is set, the underwriters try to determine what the market thinks of the valuation by arranging a roadshow.
Statement III is true.
At the end of the roadshow, customers inform the underwriters of their interest by telling the underwriters how many shares they may want to buy. After the roadshow, the underwriters add up the total demand and adjust the share price to customer demand so that the IPO is most likely to succeed. This process is called book building.
Determine which of the following statements regarding the mechanics of an IPO is TRUE.
A
When underwriters provide a firm commitment, they often intentionally overprice the IPO.
B
The over-allotment allocation is also known as red herring.
C
If the issue is a success and the price rises above the IPO offer price, the underwriters will exercise the greenshoe provision.
D
During a lock-up period following an IPO, the new shareholders cannot sell their shares.
E
In an IPO, the service fee charged by underwriters is known as the management fee.
Statement A is false.
When underwriters provide a firm commitment, they often intentionally underprice the IPO. This increases the probability all the shares will be sold at the offer price, which reduces the risk of loss for the underwriter.
Statement B is false.
The over-allotment allocation is also known as the greenshoe provision.
Statement C is true.
The greenshoe provision gives the underwriters the option to issue a limited amount of additional shares at the IPO offer price. This means the underwriter can market more shares than is listed in the prospectus.
If the issue is a success and the price rises above the IPO offer price, the underwriters will exercise the greenshoe provision so they have all the needed shares to deliver.
If the issue is not a success and the price falls below the IPO offer price, the underwriters will not exercise the greenshoe provision. Instead, they will buy shares in the open market at the reduced price, which can be used to deliver shares to the over-allotment sold.
Statement D is false.
During a lock-up period following an IPO, the pre-existing shareholders cannot sell their shares.
Statement E is false.
In an IPO, the service fee charged by underwriters is known as the underwriting spread.
Determine which of the following statements regarding IPO puzzles is TRUE.
A
The average IPO seems to be priced too high.
B
The number of IPOs is solely driven by the demand for capital.
C
The cost of an IPO is typically lower compared to the cost of other security issues such as bonds.
D
The fees for IPOs seem to be sensitive to the difference in issue sizes.
E
In the subsequent 3-5 years after their IPOs, newly listed firms appear to underperform.
E is true
In the subsequent 3-5 years after their IPOs, newly listed firms appear to underperform.
Statement A is false.
The average IPO seems to be priced too low. Underwriters tend to underprice an IPO to reduce their risk. This also biases the first-day return to be very positive.
Statement B is false.
IPOs follow a cyclical pattern in terms of volume and number of issues. This is not surprising as we would expect a greater need for capital in times of growth and a lesser need for capital during low periods of economic activity. However, since the magnitude of the swings in each cycle varies, it appears that the number of IPOs is not solely driven by the demand for capital. This cyclicality remains a mystery to financial economists.
Statements C and D are false.
Compared to the cost of other security issues, such as bonds, convertible bonds, etc., the cost of an IPO is typically much higher.
In addition, the fees for IPOs do not seem to be sensitive to the difference in issue sizes. For example, an issue size of $80 million could have the same underwriting spread as an issue size of $20 million.
Statement E is true.
Long-run performance after an IPO is poor on average. In the subsequent 3-5 years after their IPOs, newly listed firms appear to underperform. Financial economists have yet to find an explanation for why IPOs generally follow this trend.
True or false
The average IPO seems to be priced too high.
FALSE
The average IPO seems to be priced too low. Underwriters tend to underprice an IPO to reduce their risk. This also biases the first-day return to be very positive.
True or False
The number of IPOs is solely driven by the demand for capital.
False
IPOs follow a cyclical pattern in terms of volume and number of issues. This is not surprising as we would expect a greater need for capital in times of growth and a lesser need for capital during low periods of economic activity. However, since the magnitude of the swings in each cycle varies, it appears that the number of IPOs is not solely driven by the demand for capital. This cyclicality remains a mystery to financial economists.
True or False
The cost of an IPO is typically lower compared to the cost of other security issues such as bonds.
False
Compared to the cost of other security issues, such as bonds, convertible bonds, etc., the cost of an IPO is typically much higher.
