Raising Capital (W8)

Question 1

Indenture

Answer 1

Contract between bond issuer and trust company representing the bond holders’ interests

Question 2

Security (2)

Answer 2

Collateral - financial securities or asset pledged to secure loan
Mortgage securities - secured by real property

Question 3

(Bondholders’) Seniority

Answer 3

Bondholders’ are priority

Question 4

Typical Bond Covenants (4)

Answer 4

Issuing new debt
Dividends and share repurchases
Mergers and Acquisitions
Asset Disposition

Question 5

Bond Risk Categories (Highest/Lowest)

Answer 5

Aaa (Moody’s) or AAA (S&P/Fitch) = highest quality
C (Moody’s) or D (S&P/Fitch) = in default

Question 6

Bond Redemption Features (Provisions) (3)

Answer 6

Put Provisions
Call Provisions
Convertibility Provisions

Question 7

Call Provisions

Answer 7

Issuer has the option to repurchase all or part of the debt at or after a certain date –> valuable to issuer higher coupon rate and promised yield

Question 8

Put Provisions

Answer 8

Debt holder has the option to sell the debt to the company when certain exercise provisions are met –> valuable to debt holder, expect such debt to provide lower coupon rate and promised yield

Question 9

Convertibility Provisions

Answer 9

Debt can be converted into equity securities (ordinary shares) of the issuing firm at a set conversion ratio –> valuable to debt holders = lower coupon rate and promised yield

Question 10

Two Types of Bank Loans

Answer 10

Lines of Credit - setting a max amount bank willing to left
Syndicated loan - very large bank may arrange loan with a firm and then sell portions of the loan to a syndicate of other banks

Question 11

Angel Investors

Answer 11

Individual investors who buy equity in small private firms

Question 12

Venture Capital Firms

Answer 12

Financial intermediaries that are typically set up as limited partnerships, do not want to own their investment forever.

Question 13

Institutional Investors

Answer 13

Pension funds, insurance companies, endowments etc.

Question 14

IPO

Answer 14

Initial Public Offering
First issue of shares by newly listed company on stock exchange
Where most companies typically raise their equity funding

Question 15

Reasons for IPO Under Pricing (4)

Answer 15

Ensures issues are fully subscribed
Attract knowledgable investors, expecting others to follow lead
Counteract winners curs, where informed investors crowd out uninformed invesots
Provide benefit to investors so they will support future share issues

Question 16

Dutch Action Underwriting

Answer 16

Underwriter accepts a series of bits that include number of shares and price per share
Price that everyone pays is the price that will result in all shares being sold = incentive to bid high to make sure you get in on the auction

Question 17

Agency Problem of Issuing

Answer 17

Underwriter earns commission based on aggregate value meaning there is incentive to set the price high.
If unsuccessful, no commission = incentive for low price

Question 18

Cost of a public issue

Answer 18

5-10% of amount raised, lower proportional costs for larger issues

Question 19

Seasoned Equity Offerings (SEO)

Answer 19

New shares issuances by public firms after IPO

Question 20

Forms of SEOs (3)

Answer 20

Rights Issues
Private Placement
Public Issue

Question 20

Rights Issue

Answer 20

Issue of ordinary shares to existing shareholders, allows for current shareholders to avoid the dilution effect.

Question 20

Rights are given to shareholders specifying (3)

Answer 20

Number of shares that can be purchased
Purchase price
Time frame

Question 21

Shareholders can either…

Answer 21

exercise their rights or sell them (tradable/renounceable rights)

Question 22

Subscription Price

Answer 22

Price that must be paid to obtain new shares issued under rights issue

Question 23

Ex-rights Date

Answer 23

Date on which a share begins trading ex-rights, right not attached to shares from or after this date, expect price to fall.

Question 24

Cum-rights

Answer 24

When shares are traded cum–rights, buyer entitled to participate in forthcoming rights issue

Question 25

Why do you expect price to fall on ex-rights date? (2)

Answer 25

Share no longer carries the right
Dilution of share capital after the rights issue

Question 26

Private Placement

Answer 26

Issue for large parcels of shares to institutional investors or clients of a stockbroker

Question 27

Characteristics of Public Placement (4)

Answer 27

Issued at a discount to encourage investors to acquire large parcel
No registration/underwriter required
Low-cost
Disliked by existing shareholders

Question 28

Net Change in Firm Value due to Equity/Debt Issues

Answer 28

Project NPV +/- Value Effect of Financing Choice
Reason firm value can be more/less affected is asymmetric information/signalling effect.