L3 - Primary Markets and Asset Management Flashcards
What are the main areas of the Primary Markets?
- M&A
- Equity IPOs
- Bond Underwriting
- Loans –> ‘syndicated loan market’
What is the syndicated loan market?
- syndicated loan, also known as a syndicated bank facility, is financing offered by a group of lenders—referred to as a syndicate—who work together to provide funds for a single borrower. The borrower can be a corporation, a large project, or a sovereign government. The loan can involve a fixed amount of funds, a credit line, or a combination of the two.
What is the main goal of syndicated loans?
- The main goal of syndicated lending is to spread the risk of a borrower default across multiple lenders or banks, or institutional investors, such as pension funds and hedge funds.
- Because syndicated loans tend to be much larger than standard bank loans, the risk of even one borrower defaulting could cripple a single lender.
- Syndicated loans are also used in the leveraged buyout community to fund large corporate takeovers with primarily debt funding.
How are the main financial authorities in the primary market?
- In the UK the Financial Conduct authority is the primary markets regulator (in the US this is the Securities and Exchange Commission).
- The UK primary market regulations are largely set by European directives, such as the “prospectus directive” and the “transparency
directive”. - The goal though is clear – to ensure that investors have full
information about newly issued and traded securities
What is 1933 US legislation ‘The Truth in Securities Act’?
- The Securities Act of 1933 was created and passed into law to protect investors after the stock market crash of 1929.
- The legislation had two main goals: to ensure more transparency in financial statements so investors could make informed decisions about investments; and to establish laws against misrepresentation and fraudulent activities in the securities markets.
- The act—also known as the “Truth in Securities” law, the 1933 Act, and the Federal Securities Act—requires that investors receive financial information from securities being offered for public sale. This means that prior to going public, companies have to submit information that is readily available to investors.
How are Government Bonds issued?
- by auction and managed by the debt management office - their job is to raise money for the government
- these arent bought by primary bidder/bond dealers at investment banks and then sell them on to the buy side asset managements
Why do we only auction Government Bonds?
- There are lots of government bonds out there –> and those around the same date are fairly similiar
- therefore it is very simple to price the bonds, but how many are willing to buy at that price? Well to find out they auction them
- If an equities are already traded, and you want to issue more equity, a secondary offering, you can get the price based off the current shares available
- However when shares first come to market in a IPO, how much should they be worth? as there is no share price available equity bookbuilding takes a role here
What are the different types of Government bonds?
- This distinguishes index linked (IL) from conventional gilts (CV).
- A conventional gilt is a long term UK government bond, offering fixed payments of “coupon” every six months and the repayment of the
original principal at the maturity date. - It divides conventional gilts are divided into short maturity (I think maturity of less than 10 years), medium maturity (10-15 years), and long maturity (I think more than 15 years).
- An indexed gilt differs because the payments are linked to a price index, increasing along with inflation.
What is an Initial Public Offering?
- an act of offering the stock of a company on a public stock exchange for the first time.
- The primary market issue of equities (or initial public offering IPO) is also through underwriting not auction.
- there is a lead bookrunner,
whose job is to market the issue and use their contacts to establish and indicative market price. A law firm will also be needed.
What is underwriting?
- Underwriting is the process that a lender or other financial service uses to assess the creditworthiness or risk of a potential customer.
- Underwriting also refers to an investment banker’s process of packaging and selling a security on behalf of a client.
What is Bookbuilding?
- Book building is the process by which an underwriter attempts to determine the price at which an initial public offering (IPO) will be offered.
- An underwriter, normally an investment bank, builds a book by inviting institutional investors (fund managers et al.) to submit bids for the number of shares and the price(s) they would be willing to pay for them
- The process of price discovery involves generating and recording investor demand for shares before arriving at an issue price.
What are the main steps of bookbuilding?
1 -The issuing company hires an investment bank to act as underwriter who is tasked with determining the price range the security can be sold for and drafting a prospectus to send out to the institutional investing community.
2 -Invite investors, normally large scale buyers and fund managers, to submit bids on the number of shares that they are interested in buying and the prices that they would be willing to pay.
3 - The book is ‘built’ by listing and evaluating the aggregated demand for the issue from the submitted bids. The underwriter analyzes the information then uses a weighted average to arrive at the final price for the security, which is termed the ‘cut off’ price.
4- The underwriter has to, for the sake of transparency, publicize the details of all the bids that were submitted.
5- Allocate the shares to the accepted bidders.
What is a Book Runner?
- The book runner is the primary underwriter or lead coordinator in the issuance of new equity, debt, or securities instruments. In investment banking, the book runner is the lead underwriting firm that runs or is in charge of the books.
- A large, leveraged buyout could involve multiple businesses. The book runner, representing one of the participating companies, coordinates with the other participating firms.
- Typically, one company takes the responsibility of running or managing the books, though more than one book runner (joint book runner) can control a security issuance.
Why would a company prefer so have a small IPO only offering a fraction of the company?
- keep control of the firm
- only need specific money for investment
- realise some profit for the intial founders of the firm
What is the recent theme of IPOs?
- share prices rise above the IPO intially then fall well below it a few years after
What are the challenges of establishing market price?
- You should be aware that establishing a market price for a newly issues private sector security is difficult (not such a problem for government bonds because there are many similar bonds already on the market, an
auction without an underwriter or bookrunner can work well). - The problem is what economist John Maynard Keynes referred to as the
Beauty Contest
What was Keynes quote about the Beauty Contest?
“…professional investment may be likened to those newspaper competitions in
which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are
looking at the problem from the same point of view. It is not a case of choosing those
which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth
and higher degrees.”
Why did Keynes use the analogy of the Beauty contest to desribe why stock prices move so much?
- Keynes used this analogy to help explain why stock market prices vary so much, over short periods of time, without regard to fundamentals.
- His explanation is changes in the views of what others think of the market values.
- This is applicable whenever investors are concerned with the short run performance of their investments, over a few days; and especially so with the issue of a new security
- No investor need pay more than the average view of other investors, because the security can always be bought later in the after-IPO secondary market.
How does Goldman Sachs Bookbuilding relate to the ‘Beauty Contest’?
- to figure out their share price they are asking all the investors at what price they would buy the stock
- in essense trying to find the average price that all investors generally agree on for the value of the company and its stock
What are Corporate bonds?
- A corporate bond is a debt security issued by a corporation and sold to investors. The backing for the bond is usually the payment ability of the company, which is typically money to be earned from future operations. In some cases, the company’s physical assets may be used as collateral for bonds.
How are Corporate Bonds issued?
- Corporate bonds are not issued by auction. This is because of the difficulty of analysing the risks of the issue and establishing market price
- Every bond has a lead
underwriter or bookrunner, an investment bank who (working with other
banks) is responsible for producing the required prospectus and marketing the bond issue (through a so called roadshow) - A law company is also needed to ensure the issue is legal and complies
with regulation.
What is the difference between the buy side and sell side when issuing corporate bonds?
- There is a very clear difference between “buy side” and “sell side” in
these issues. The underwriting bank is on the sell side, representing the
issuer and trying to get as high a price for the issue as possible. The road show involves meetings with sell side asset managers, seeking to persuade them to buy. - The investment bank managing the issue is often called a “bookrunner”,
because as part of the marketing they engage with their buy side contacts to ascertain how much of the bond they would be willing to buy at different prices (the ‘book’ indicating interest not firm commitment). - They use the book to price the issue, often a little below the eventual market price to reward their buy side contacts for buying into the issue.
What are some other types of private sector bonds?
- loan backed securities
- Islamic bonds or sukuk
- Government bonds –> issued internationally in London
- non-financial corpoarte bonds
What are Loan-backed securities?
- also called An asset-backed security (ABS) is a financial security such as a bond or note which is collateralized by a pool of assets such as loans, leases, credit card debt, royalties, or receivables. For investors, asset-backed securities are an alternative to investing in corporate debt. An ABS is similar to a mortgage-backed security, except that the underlying securities are not mortgage-based.
What are Islamic bonds?
A sukuk is an Islamic financial certificate, similar to a bond in Western finance, that complies with Islamic religious law commonly known as Sharia. Since the traditional Western interest-paying bond structure is not permissible, the issuer of a sukuk sells an investor group a certificate, and then uses the proceeds to purchase an asset, of which the investor group has partial ownership. The issuer must also make a contractual promise to buy back the bond at a future date at par value
What are Gilts?
- Government bonds in the U.K., India, and several other Commonwealth countries are known as gilts. Gilts are the equivalent of U.S. Treasury securities in their respective countries.
- The term gilt is often used informally to describe any bond that has a very low risk of default and a correspondingly low rate of return. They are called gilts because the original certificates issued by the British government had gilded edges.
- Gilts are government bonds, so they are particularly sensitive to interest rate changes.
- They also provide diversification benefits because of their low or negative correlation with stock markets. Gilts often respond strongly to political events, such as Brexit.
