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195
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The Capital Market
“Mr. Morgan, will the market go up or down?” “Yes.”
EXCHANGE BETWEEN A JOURNALIST
AND J.P. MORGAN
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ANSWERS TO QUESTIONS
1. A public issue of securities is to multiple investors, sometimes in the hundreds or thousands.
The Securities and Exchange Commission (SEC), as well as state securities offices on
2. With a traditional (firm commitment) underwriting, a syndicate of investment bankers is
usually formed either to bid on an issue or to underwrite the issue on a negotiated basis. The
issue must go through normal registration processes with the SEC, and these take around 40
3. In a best efforts offering, the investment banker agrees only to do its best in selling the
issue. There is no guarantee of sale, as there is in an underwriting where the investment
4. Private debt issues have similar advantages to similar such stock issues. The flexibility
obtained in terms of speed and disclosure requirements is very important. Again, the firm
avoids high flotation costs especially on small issues. Disadvantages stem from the limited
5. Since many of the costs associated with the flotation of an issue are basically fixed, the
6. In certain cases, forcing a company to sell securities through a rights offering would work to
the disadvantage of shareholders. Where existing shareholders do not have the funds or
7. The usual reasons cited for the popularity of rights offerings include a cheaper flotation cost
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition, Instructor’s Manual
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Some other reasons include the possible speculative appeal of rights due to their leverage
Finally, many observers feel that rights offerings are used because they are well-received by
8. The subscription price and its discount from current share price determine the success of the
rights offering. As long as the market price of the stock remains comfortably above the
9. In a
standby arrangement, the rights offering is underwritten by an investment bank that
agrees to purchase any leftover shares. With an oversubscription privilege, shareholders are
10. The Securities and Exchange Comission (SEC) is the principal regulatory authority overseeing
the issuing of securities to the public. Its role is to assure that full and fair material
11. a. Public,
12. The costs of a private placement are twofold: initial fixed costs and ongoing interest costs.
13. With shelf registrations, larger companies are able to quickly tap the public market while
14. The venture capitalist hopes that a portion of his/her investments will be very successful.
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stock to the general public, and the price will be many times the price paid for it by the
There is no liquidity in the new venture investment until the company goes public. For the
successful venture, this usually takes at least five years from the time the company is
15. The common stock price reaction to a security offering announcement is due to an
information effect. The information may have to do with future cash-flow expectations.
More likely, the effect is due to asymmetric (unequal) information between the investors
16. A shelf registration is a procedure that allows a company to register securities in advance
that it may want to sell and essentially put that registration “on the shelf” until it makes a
Both “seasoned issuers” and WKSIs can use a regular shelf registration, but only WKSIs
can use an automatic shelf registration.
SOLUTIONS TO PROBLEMS
1. a. (1) Number of bonds issued = $1.8 billion / $1,000 = 1,800,000 bonds
Total underwriting spread =
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition, Instructor’s Manual
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(2) Total underwriting spread =
Total out-of-pocket expenses =
(*NOTE: $1.8 billion / $75 million = 24 times)
Total flotation costs =
b. The shelf registration method.
2. a. 800,000 shares outstanding 4rights per share
200,000 new shares =
PS$50 $40 $10
−−
X
N + 1 4 + 1 5
3. a. O
O
PS$50 $40 $10
R$1.67
N + 1 5 + 1 6
−−
== ==
(P ) (N) + S ($50) ($5) + $40 $290
X
N55
4. a. Company Y has the larger issue relatively. It is issuing 1 new share for each of the 4 old
shares that are outstanding, or an increase of 25 percent. Company X is issuing 1 new
b. The theoretical value of one share of stock when it goes “ex-rights” is:
($48) (14) + $42
The lower theoretical value of Company Y is due to its having a larger relative offering.
Its “ex-rights” theoretical value is somewhat closer to the subscription price, $46.70 –
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5. No solution recommended. The type of analysis required will vary with the situation
chosen. The problem points to certain directions that might be taken.
SOLUTIONS TO SELF-CORRECTION PROBLEMS
1. a. O
O
P-S $150 - $125 $25
R= = = =
N + 1 9 + 1 10 $2.50
O
(P ) (N) + S ($150) (9) + $125 $1,475
2. a. Public issue:
Number of $1,000-face-value notes to be issued to raise $6 million (to nearest note) =
Private placement:
The public issue has the higher total costs. As the interest payments are spread out over
b. Public issue:
Private placement:
The private placement has the higher total costs. With a longer-term loan, the
differential in interest rate becomes more important.
