Week 6 Lecture Notes
Can you believe it! Week 6 is here! Yes, there is more to learn!!! Actually there is
always something to learn in every topic but this week we will concentrate on
investment banking and long-term debt.
The lecture this week will discuss investment banking, dilution of earnings,
analyzing long-term debt, bond yield and prices.
The investment banker links the firm with the investor. They help firms raise
money by lending their expertise to a company to help it determine the best
strategy and the best place to raise either debt or equity capital. They prepare all
the necessary documents to accurately present the value proposition for funding
and to protect both the company and the investor from any misunderstandings.
This is more than just a business plan. Good investment banks prepare something
called a private placement memorandum--or PPM--which is a legal document
designed to protect both sides from making a bad investment. They ensure that all
government regulations have been followed in the raising of any capital.
The spread is the difference between the amount paid to an issuer of securities in a
primary distribution and the public offering price. The amount of spread varies
widely, depending on the size of the issue, the financial strength of the issuer, the
type of security involved (stock, bonds, rights), the status of the security (senior,
junior, secured, unsecured), and the type of commitment made by the investment
bankers. The range may be from a fraction of 1% for a bond issue of a big utility
company to 25% for the Initial Public Offering of a small company.
Pricing a security is a challenging task. If a security is priced too high, it will not
sell, causing the underwriters to suffer a loss. If a security is priced too low, it
may rise quickly in price within a secondary market, denying the issuer just
compensation for the security. Most investment banking firms have allied
brokerage and market-making businesses that provide insight into appropriate
security prices. As brokers, they constantly buy and sell securities on behalf of
clients. As market makers, they establish prices by buying and selling securities
for their own accounts. In order to facilitate the selling of a large new issue, a
managing underwriter will attempt to stabilize the price by announcing its
willingness to buy at the offering price on the secondary market any of the new
securities that recent buyers have decided they would rather not hold. Initially,
underwriters may sell more than the allocated number of securities in order to
ensure that they have some buying power to repurchase these shares.
Dilution is an increase in the number of shares of a company's stock, causing the
value of each share to decrease. The number of shares increases when the