Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Chapter 17: Investment Banking and Securities Law
Multiple Choice Questions
1. Section: 17.1 Conflicts between Issuers and Investors
Learning Objective: 17.1
Level of difficulty: Basic
2. Section: 17.1 Conflicts between Issuers and Investors
Learning Objective: 17.1
Level of difficulty: Intermediate
3. Section: 17.1 Conflicts between Issuers and Investors
Learning Objective: 17.1
Level of difficulty: Intermediate
4. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.2
Level of difficulty: Intermediate
5. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.2
Level of difficulty: Basic
6. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.3
Level of difficulty: Intermediate
7. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.3
Level of difficulty: Basic
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
8. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.3
Level of difficulty: Intermediate
In the exempt market, the issuer prepares an offering memorandum, instead of a prospectus.
9. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.3
Level of difficulty: Intermediate.
10. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
11. Section: 17.4 Post-IPO Regulation and Seasoned Offerings
Learning Objective: 17.5
Level of difficulty: Basic
12. Section: 17.4 Post-IPO Regulation and Seasoned Offerings
Learning Objective: 17.5
Level of difficulty: Intermediate
Practice Problems
Basic
13. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Basic
Solution:
14. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of Difficulty: Basic
Solution:
The waiting period occurs after the preliminary prospectus has been drafted and sent to the
15. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Basic
Solution: The net proceeds were $25 million × (1 – 0.028) – $150,000 = $24,150,000.
Intermediate
16. Section: 17.1 Conflicts between Issuers and Investors
Learning Objective: 17.1
Level of difficulty: Intermediate
Solution:
a. Arthur pays $0.85 x 100,000 = $85,000 for the stamps. He sells them for $0.86 × 100,000 =
17. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.2
Level of difficulty: Intermediate
18. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.2
Level of difficulty: Intermediate
Solution: The OSC determined three types of security distribution as follows: distribution by the
19. Section: 17.2 A Primer on Securities Legislation in Canada
Learning Objective: 17.3
Level of difficulty: Intermediate
Solution:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Three major categories of exempt purchasers are:
20. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution:
Stage 1: Initial discussion with the investment bank, which forms the formal IPO process.
21. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution: Limit orders are expressions of interest, but not firm orders. Investors enter into limit
22. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution: During the quiet period, the investment dealer cannot issue an analyst report
23. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution:
The four types of public offerings are a best efforts offering, a firm commitment offering, a
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
own shares; can only be used with seasoned offerings.
24. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution:
25. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution:
26. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution:
The marketing of the issue will involve “road shows” or “dog and pony” shows to describe the
27. Section: 17.4 Post-IPO Regulation and Seasoned Offerings
Learning Objective: 17.5
Level of difficulty: Intermediate
financial statements, annual information forms (AIFs), and proxy and information circulars.
28. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution:
There are 500,000 shares outstanding before the IPO, and 250,000 new shares are being issued,
29. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution:
The IPO is intended to sell 250,000 + 250,000 = 500,000 shares. When investor demand is
30. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Intermediate
Solution:
a. To raise $4 million, the equity offering, before fees, will have to be $4,000,000 / (1 – 0.06) =
Challenging
31. Section: 17.1 Conflicts between Issuers and Investors
Learning Objective: 17.1
Level of difficulty: Challenging
Solution: The probability of a fraudulent bond is 1/8 = 0.125, and the probability of a non-
32: Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of difficulty: Challenging
Solution:
There is too little competition for business in Canada, and Canadian firms do not need to tolerate
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
33. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of Difficulty: Challenging
Solution: With fees of 4 percent, Lansdowne Ltd. will receive 96 percent of the offer price for
underwriters since it will be easier to sell the issue at a lower price.
34. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of Difficulty: Challenging
Solution:
Under Plan I, you will gross $11 × 1 million shares = $11 million and will pay $11 million ×
35. Section: 17.3 IPOs and Investment Banking
Learning Objective: 17.4
Level of Difficulty: Challenging
Solution:
a. On the undervalued shares, your profit will be 1,000 shares × $3 = $3,000. On the overvalued
36. Section: 17.3 IPOs and Investment Banking
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Learning Objective: 17.4
Level of Difficulty: Challenging
Solution:
a. Working down from the top of the list (highest limit price), selling 800,000 shares means that
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Answers to Concept Review Questions
17.1 Conflicts between Issuers and Investors
Concept review questions
1. How does the existence of asymmetric information lead to market inefficiencies?
Information asymmetry means that people frequently have different information about the same
2. Why can increases in interest rates not be used to solve the “lemons problem” in markets?
Let us take a typical example of “lemons problem”. Suppose bad money drives out good. If the
3. Why are securities legislation and corporate laws essential for markets to perform properly?
17.2 A Primer on Securities Legislation in Canada
Concept review questions
1. What are some of the more important issues arising from the fact that securities regulation is a
provincial and territorial, but not a federal, responsibility in Canada?
Securities regulation is designed to protect investors in that jurisdiction, so the provincial and
2. Why are prospectuses so important for public market issues?
The assumption here is that the issuer, controlling shareholders, or the restricted shareholders
3. Explain how offering memorandums differ from prospectuses and how exempt markets differ
from public markets.
First, they differ in content. Memorandums are short, have much less information, and have
lower cost of preparation. Second, they are used in different situations. Memorandums may have
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
4. What is a reverse takeover and a backdoor listing?
A reverse takeover occurs when a takeover firm is acquired that has reduced its operating
17.3 IPOs and Investment Banking
Concept review questions
1. Briefly discuss the possible motivation for firms to enter into IPOs, and relate these
motivations to the five stages of firm development discussed by Myers (1999).
The motivations are “cash out” and access to more diversified set of financing options. Myers
2. List and briefly describe the four basic stages of the IPO process.
The four basis stages are as follows:
i. Discussion triggers IPO
3. List and briefly describe some possible reasons for the existence of IPO underpricing.
First, it lowers the risk of the underwriter losing money on the issue. Second, the underpricing in
US is the litigious nation of the US economy. If the share price falls, then the risk is high that
17.4 Post-IPO Regulation and Seasoned Offerings
Concept review questions
1. Explain why the lock-up period is an important consideration for investors, especially for
issues that are still largely held by insiders.
Large issuer insiders want to cash out their shares. Without the lock-up period, stock prices may
2. How do continuous disclosure requirements protect investors?
3. Briefly explain why short-form prospectuses are permitted by regulators for a large percentage
of seasoned issues, and explain why they have led to the growth in popularity of bought deals.
Essentially, any reporting issuer with an outstanding Annual Information Form can issue
securities under a short-form prospectus, which indicates the nature and pricing of the securities,