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Corporate Financial Decision Making > Raising Equity > Flashcards

Raising Equity Flashcards

1
Q

What is equity?

A

Equity is a way of raising funds by issuing shares

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2
Q

What are some equity characteristics?

A
  • Permanent contribution of capital
  • Ordinary shareholders have full voting rights
  • Shareholders have a residual claim (paid last via dividends and if company is liquidated)
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3
Q

What is an IPO?

A

An IPO or Initial Public Offering is the process of offering shares of a private corporation to the public in a new stock issuance

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4
Q

What are the steps of an IPO?

A

Step 1: Engage the Investment Banker
Step 2: Gauge interest in securites in market
Step 3: Set price and list

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5
Q

What happens in the engagement of an investment banker?

A

Investment bankers help you prepare the prospectus and provide services such as underwriting

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6
Q

What is the prospectus?

A

The prospectus is a legal document detailing the IPO and is also used as a marketing docuement

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7
Q

What is an underwriter?

A

An insititution such as a bank who, for a fee, garuntees that all shares will be sold and liable to purchase shares at the conclusion of float.

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8
Q

Why does the underwriter want to promote the shares?

A

Since they are liable to buy the shares if they cannot sell every share at the conclusion of the float, they have incentive to try and sell the shares as hard as they can

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9
Q

Why do you underwrite an IPO?

A

This is insurance on the float and ensures that the float will succeed in the issueing firms eyes.

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10
Q

What are the two main ways a firm can determine the subscription price of the IPO?

A

Fixed Pricing-Price set, prospectus sent out and offers recieved
Book Building-Competitive bidding by institutional investors and bids are used to determine the subscription price

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11
Q

What is the other way to set price that is less popular?

A

Bidding-Let people bid for individual securities and bidders get the security

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12
Q

What do underwriters do to gauge interest?

A

They elliciate non-binding orders from institutional investors in a process called book-building. This allows forms to determine the subscription price for shares

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13
Q

What happens when the subscription price is too high?

A

The float fails as securites are not bought by investors

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14
Q

What happens when the subscription price is too low?

A

They suffer an oppurtunity cost as they could’ve priced the security higher

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15
Q

In what market are the shares issued?

A

The primary market as they raise funds directly to the company who issued the shares

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16
Q

Once issued, in what market is a share traded in from then on?

A

They are traded within the secondary market as they raise funds for the seller of the funds not the company who issued the shares

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17
Q

Is a firm more likely to underprice or overprice their shares in an IPO?

A

Firms are more likely to underprice

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18
Q

What are the reasons for underpricing?

A

Infomation Asymmetry, Market Feedback Hypothesis, Investment Banking Conflicts, Litigation Insurance, Signalling

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19
Q

What is infomation asymmetry?

A

The idea that investors are either informed or uninformed which allows them to determine if underpricing has occured. To keep uninformed investors in the market - need to make sure that IPO’s are significantly underpriced

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20
Q

What is the Market Feedback Hypothesis?

A

Issuer’s uncertain as to the true value of the firm. Book-building offers issuers a way to find out the firm value. To induce this info to be disclosed, the issuer must underprice the shares.

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21
Q

What are Investment Banking Conflicts?

A

IB’s arrange underpricing to benefit themselves and their clients as underpricing can reduce the banks own costs and can be used to develop unethical relationships with other clients

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22
Q

What is Litigation Insurance?

A

Potential liability in issuer/underwriter misstatements/omissions to do with IPO. Underpricing ensures subscribers have positive return and reduce the likely hood of being sued.

23
Q

How does an IPO convey signalling?

A

IPO is the first stage of expansion into capital markets. Leaving a good taste in investors mouths will allow the firm to raise more capital easier later on.

24
Q

What are the reasons for long run underperformance of IPOs?

A

“Clientele effects”, “Impressario Hypothesis” and “Window of oppurtunity”

25
Q

What is the “clientele effect”?

A

Only optimistic investors buy into an IPO, but their optimism will disappear as more information about the firm is released

26
Q

What is the “impressario hypothesis”?

A

IB’s attempt to create apperance of excess demand by initially underpricing IPO’s. Investors are usually taken by this but a share price drop occurs when IB’s efforts are withdrawn.

27
Q

What is the “window of oppurtunity”?

A

Management times the issue in hot markets and when there is a decline in demand for IPO’s after hot markets are correlated generally with equity prices after IPO’s

28
Q

What is a SEO?

A

A new equity issue from a company that is already publicly traded

29
Q

What types of SEO’s are there?

A

Rights Issue (Exsisting Shareholders), General Offer (Public) and Placements (Financial Institutions)

30
Q

What is a placement?

A

An issue of new shares to a limited number of investors (generally financial institutions)

31
Q

What are the advantages of a placement?

A 
-Quick to complete (a few
weeks)
-Lower issue costs (no need
for underwriting normally)
-Do not generally require a
prospectus
32
Q

What are the disadvantages of a placement?

A 
-Shares issued at a discount
⇒ transfer of wealth from
existing shareholders to new
investors
-Dilute control (votes) of
existing shareholders
33
Q

What is ASX Listing Rule 7.1?

A

It prohibits a company from issuing more than 15%
of its issued capital within a given 12 month period without first
obtaining the approval of its shareholders

34
Q

What is a rights issue?

A

An offer by a company of new shares at a fixed price on a pro-rata basis. Shareholders have entitlement to shares based on how many they currently own. Issue price 10-30% to shareprice in live market. Takes at least 23 days to complete

35
Q

What is the value of right (R) equation?

A

R = N(M-S)/(N+1) = X-S where S is the sub price, N is the pro-rata entitlement (1:N), M is the market price of share cum-rights and X is the theoretical ex-rights price

36
Q

What is the theoretical ex-rights price (X) equation?

A

X = (NM+S)/(N+1)

37
Q

What happens when you exercise a rights issue?

A

You experience no wealth loss, no voting loss but you don’t recieve any cash

38
Q

What happens when you do nothing with a rights issue?

A

You experience voting loss, wealth loss but you keep cash

39
Q

What happens when you sell rights?

A

You keep cash and experience no wealth loss but do lose voting rights

40
Q

Why might the share price not fall to the theoretical ex-rights price?

A
  • Info on ex-rights date revealed
  • Transaction costs/taxes related to exercising the rights
  • R ignores the option characteristic of the right
41
Q

Why would a rights issue be preffered over a private placement?

A
  • Constraints on private placements
  • Convinient source of funds
  • Preserves voting patterns
42
Q

Why would private placements be preffered over a rights issue?

A
  • Takes longer than placements

- Cost more than placements

43
Q

What is an AEO?

A

An accelerated entitlement offers is a offer that gives different conditions to different shareholders

44
Q

What are the two stages of an AEO?

A
  • Accelerated offer to institutional shareholders

- Offer to retail shareholders

45
Q

What are the three main types of AEO?

A
  • Accelerated Non-renounceable Entitlement Offer (JUMBO)
  • Accelerated Renounceable Entitlement Offer (AREO)
  • Simultaneous Accelerated Renounceable Entitlement Offer (SAREO)
46
Q

What are the advantages of AEO?

A

It allows funds to be raised quickly whilst allowing retail investors a chance to participate

47
Q

What is a dividend reinvestment plan?

A

Use part/all of a dividends to apply for new shares without transaction costs and usually at a discount. Substantial source of capital for major corporations. Allows a high dividend payout while while lessening impact on cashflows

48
Q

What are the objective of regulatory bodies?

A

-Investor protection

49
Q

What must a security offer be accompanied by?

A

If it is not an exclusive offer, it needs to be accompanied by a prospectus

50
Q

What are the costs associated with an IPO?

A
  • Underwriting fees

- Direct costs to management, lawyers, accountants as well as registering the new securities

51
Q

What are some types of private equity?

A
  • “Angel finance”-Informal market for direct equity provided by small number of high net worth individuals
  • Venture capital-Active financial intermediary providing early stage financing for high potential start ups
52
Q

What are the advantages of going public?

A
  • Access to additional capital
  • Allow venture capitals an exit
  • Current shareholders can diversify
  • Liqquidity is increased
  • Allows establishment of firm value
  • Makes it more feasible to use stocks as employee incentives
  • Increase customer recognition
53
Q

What are the disadvantages of going public?

A
  • IPO creates substantial fees
  • Greater degree of disclosure and scrutiny
  • Dilution of control of existing owners
  • Sp[ecial deals to insiders will be more dificult to undertake
  • Managing investors relations is time consuming

Corporate Financial Decision Making (4 decks)

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