Primary Market Makers & Indices Flashcards
Advantages of Primary Market
The shares may be priced at an attractive level to ensure good take-up,
Transaction costs will generally be lower / no dealing commissions, and
There may be a limited supply of shares. Financial institutions such as pensions funds may require exposure to a specific newly-listed company and this demand may force the price higher than the initial offer price
Disadvantages of Primary Market
No track record for the company’s commercial (business) / investment (share price) performance: a lack of hard factual trading data to analyse,
Companies generally list via IPO at times which are “favourable” to the company’s existing management / founders: not “favourable” to investors! A substantial amount of financial accounting “window dressing” may well take place!
There may be less stringent reporting requirements at the time of the IPO
Share allocations may be scaled-back if the issue is over-subscribed: ie. investors in the IPO may get less shares than they applied for,
At initial listing the share price may be subject to high volatility.
Offers for Sale
An offer for sale involves the company issuing the new shares selling the issue to a company called an issuing house, typically merchant banks, investment banks, and brokers offer this service.
-The issuing house will buy the shares from the company at a lower price than it intends to sell them, so they can make a profit.
- The company directors will prepare a detailed prospectus called an offer document, which needs to be assessed by an independent specialist consultant.
- An advert called a “formal notice” will be placed in the newspaper.
Fixed Price
A fixed price is stated and offered on that basis (sometimes this initial price is set low to encourage take up). The fixed
price is typically set at the price just below where they could realistically expect full take-up, and to encourage an active secondary market. Sometimes, shares can be oversubscribed as the shares are being marketed too cheaply. The offer document
will contain instructions on how to handle this. Due to these issues, and the difficulty in setting a fixed price, companies often prefer to use a tender basis.
Tender
Investors make bids for amounts of stock and the price they’re willing to pay.
Based on the bids, a strike price is set, with anyone who bid above the strike price paying the strike price for the stock. The advantage here is that the market has had an input in the pricing of the share, and the potential for oversubscription is limited.
Offer for Subscription
An offer for subscription involves a company issuing shares directly to the general public and offering them for sale direct (subscription). This typically involves an issuing house
underwriting the offer, meaning they’ll agree to purchase any unsold shares for a fee. This method is rarely used these days and then typically only be new investment trusts. An offer for subscription can either be on a fixed or tender price basis.
Placement/Selective Marketing
The shares are marketed directly to preferred, specially selected institutional investors, hence the term “selective marketing”. These investors include pension funds, investment banks, and life funds. The advantage is that the prospectus doesn’t have to be quite as detailed, and companies may find this the cheapest way to sell their issue. It’s a popular option.
Introduction
This involves a company already listed on one exchange the ability to “seek an introduction” to sell shares on another exchange. No new shares are issued – this gives foreign companies new markets to sell their shares, and domestic investors access to the shares of
foreign companies they may not otherwise have access to.
Share Price and Valuation
Shares have a nominal/face/par value shown on the face of the share certificate.
The market value is the trading price of the share on the market. This is the capital value of that share in the market and used to provide the total ‘capitalised’ value of the company:
shares issued x market value = capitalisation
Gordons Growth Model (GGM)
It calculates the (ex-dividend) price of a share, assuming constant dividend growth and dividend payments made at the end of each period.
It helps place a price on value of an ordinary share with reference to the dividend. But, it is simplistic and only really suitable for mature shareholdings with track record.
Most recent dividend / required return - growth rate of dividend
Limitations of GGM
-If the required return is less than the growth rate of the dividend, the model gives a negative share valuation.
- If the required return is equal to the growth rate of the dividend, the formula collapses as the result approaches infinity.
- It’s only valuing the share based on dividend, which is a single fundamental, which should considered in whole. What if the company is very profitable, but it’s retaining its earnings and using them to invest back into the company?
FTSE 100
-Top 100 UK companies based on market capitalisation
-Weighted by market capitalisation.
-That are listed in the UK, denominated in UK Sterling or Euros on SETS.
-That meet the LSE’s listing rules and requirements such as regarding nationality, free float and liquidity tests.
-FTSE 100 Index constituents are reviewed / revised quarterly.
-The FTSE 100 Index started in January 1984 at an index level of 1,000
FTSE 250
This index provides a benchmark for the next 250 biggest companies
FTSE 350
A combination of the FTSE 100 and the FTSE 250
