Chapter 19 - Chapter 19 - The Process of Raising Capital 1....

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Chapter 19 - The Process of Raising Capital
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1. Initial Public Offerings Unseasoned new issue - Initial Public Offering (IPO) Selling stock to the public for the first time Seasoned issue Selling additional shares when some shares already public trade All new securities issues must be registered with the SEC Registration statement filed with the SEC Preliminary prospectus or red herring distributed to public Tombstone advertisements for issue are printed before SEC approval- no price given after SEC approval- price is given
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Investment bankers and IPOs Firm commitment arrangement Investment banker agrees to purchase shares Investment banker agrees to resell the shares to public Difference between price banker pays and price they sell at is agreed upon in advance- called underwriter spread Investment banker bears risk that issue will not sell Typically investment bankers form a group to manage the deal- called an underwriting syndicate Best efforts arrangement Investment banker does not purchase shares Investment banker attempts to sell shares- earns commission on sales
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How do firms agree on terms with an investment banker? A. Competitive offers B. Negotiated offer What is the incentive of an investment banker to choose a fair price for a new security issue? Pricing a new security is extremely difficult Investment banker has better information and ability to choose fair price than anyone else If investment banker on average prices issues too high, buyers in the future will not want to buy from that banker If investment banker on average prices issues too low, issuers in the future will not want to use that investment banker Reputation of investment banker should provide them with an incentive to price issues accurately
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Do investment bankers on average price IPOs fairly? Answer- NO! Fact: 10,626 U.S. IPOs were conducted between 1960 and 1992. Average first day return of 15%. How should issuers feel about this underpricing? Explanations for underpricing: i. makes issue easier to sell ii. low price affects the price path in the future iii. winner’s curse
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Example of winner’s curse: Underwriter needs to sell 1 million shares Two types of investors: informed and uninformed Uninformed investors : willing to buy 1 million shares at a fair price accurately assess true value of the shares at: $10 with prob.=.5 $12 with prob.=.5 Informed investors : know if the shares are worth $10 or $12 willing to order 1 million shares if offer price is less than the true value Suppose underwriter offers shares at $11 Claim : If the uninformed purchase shares for $11, on average they will lose $$
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Chapter 19 - Chapter 19 - The Process of Raising Capital 1....

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