How Firms Issue Securities
Investments
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¾Investment Banking
CHAPTER 3
¾Shelf Registration
Cover image
¾Private Placements
¾Initial Public Offerings (IPOs)
How Securities Are
Traded
Slides by
Richard D. Johnson
McGraw--Hill/Irwin
McGraw
Copyright © 2008 by The McGraw
McGraw--Hill Companies, Inc. All rights reserved
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Primary vs. Secondary Security Sales
Investment Banking Arrangements
¾Underwritten vs. “Best Efforts”
¾Primary
– New issue
– Key factor: issuer receives the proceeds
from the sale
– Underwritten: firm commitment on proceeds
to the issuing firm
– Best Efforts: no firm commitment
¾Secondary
¾Negotiated vs. Competitive Bid
– Existing owner sells to another party
– Issuing firm doesn’t receive proceeds and
is not directly involved
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– Negotiated: issuing firm negotiates terms with
investment banker
– Competitive bid: issuer structures the offering
and secures bids
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Figure 3.1 Relationship Among a Firm Issuing
Securities, the Underwriters and the Public
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Shelf Registrations
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¾SEC Rule 415
¾Introduced in 1982
¾Ready to be issued – on the shelf
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Private Placements
Figure 3.2 A Tombstone Advertisement
Private placement: sale to a limited
number of sophisticated investors not
requiring the protection of registration
¾Allowed under Rule 144A
¾Dominated by institutions
¾Very active market for debt securities
¾Not active for stock offerings
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Initial Public Offerings
Figure 3.4 Long-term Relative Performance of Initial
Public Offerings
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¾Process
– Road shows
– Bookbuilding
¾Underpricing
– Post sale returns
– Cost to the issuing firm
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Figure 3.3 Average Initial Returns for IPOs in Various
Countries
Types of Secondary Markets
¾Direct search
¾Brokered
¾Dealer
¾Auction
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Types of Orders
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Figure 3.6 Price-Contingent Orders
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Instructions to the brokers on how to
complete the order
¾Market
¾Limit
¾Stop loss
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Figure 3.5 Limit Order Book for Intel
on ArcaEx Exchange
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Trading Mechanisms
¾Dealer markets
¾Electronic communication networks
(ECNs)
¾Specialists markets
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U.S. Security Markets
Table 3.1 Partial Requirements for Listing
on Nasdaq Markets
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¾ Nasdaq
¾ Small stock OTC
– Pink sheets
¾ Organized Exchanges
– New York Stock Exchange
– American Stock Exchange
– Regionals
R i
l
¾ Electronic Communication Networks (ECNs)
¾ National Market System
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Nasdaq
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New York Stock Exchange
¾Member functions
¾National Market System
¾N d S
¾Nasdaq
SmallCap
llC M
Market
k t
– Commission brokers
¾Levels of subscribers
– Floor brokers
– Specialists
– Level 1 – inside quotes
– Level 2 – receives all quotes but they can’t
enter quotes
– Level 3 – dealers making markets
¾Block houses
¾SuperDot
– SuperMontage
¾OTC Bulletin Board
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Table 3.4 Block Transactions on the
New York Stock Exchange
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Table 3.2 Seat Prices on the NYSE
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Table 3.3 Some Initial Listing
Requirements for the NYSE
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Table 3.5 Electronic Computer Networks (ECNs)
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Market Structures in Other Countries
Costs of Trading
¾London - predominately electronic trading
¾Commission: fee paid to broker for
making the transaction
¾Euronext – market formed by combination
of the Paris, Amsterdam and Brussels
exchanges
¾Spread: cost of trading with dealer
– Bid: price dealer will buy from you
– Ask: price dealer will sell to you
¾Tokyo Stock Exchange
– Spread:
p
ask - bid
¾Combination: on some trades both are
paid
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Figure 3.7 Dollar Volume of Trading
in Major World Markets, 2004
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Margin Trading
¾Using only a portion of the proceeds for an
investment
¾Borrow remaining component
¾Margin arrangements differ for stocks and
futures
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Stock Margin Trading
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Margin Trading - Maintenance Margin Ex. 3.1
¾Maximum margin is currently 50%; you can
borrow up to 50% of the stock value
Stock price falls to $70 per share
N
New
P
Position
iti
¾Set by the Fed
Stock $7,000
¾Maintenance margin: minimum amount
equity in trading can be before additional
funds must be put into the account
Borrowed $4,000
Equity
$3,000
Margin% = $3,000/$7,000 = 43%
¾Margin call: notification from broker you
must put up additional funds
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Margin Trading - Initial Conditions Example 3.1
X Corp
$100
60%
Initial Margin
40%
Maintenance Margin
100
Shares Purchased
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Margin Trading - Margin Call Example 3.2
How far can the stock price fall before a
margin call?
(100P - $4,000)* / 100P = 30%
Initial Position
Stock $10,000 Borrowed
Equity
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$4,000
P = $57.14
$
$6,000
* 100P - Amt Borrowed = Equity
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Table 3.6 Illustration of Buying Stock
on Margin
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Short Sale - Initial Conditions
1,000 Shares
I iti l M
Initial
Margin
i
40%
$100
Maintenance Margin
Initial Price
Sale Proceeds
$100 000
$100,000
Margin & Equity
Stock Owed
50,000
100,000
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Short Sales
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Short Sale - Maintenance Margin
Purpose: to profit from a decline in the
price of a stock or security
Mechanics
Stock Price Rises to $110
Sale Proceeds
¾Borrow stock through a dealer
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Dot Bomb
50%
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$10,000
¾Sell it and deposit proceeds and margin in
an account
Initial Margin
5,000
Stock Owed
11,000
¾Closing out the position: buy the stock
and return to the party from which is was
borrowed
Net Equity
Margin % (4000/11000)
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4,000
36%
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Short Sale - Margin Call
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How much can the stock price rise before a
margin call?
($150,000* - 1000P) / (100P) = 30%
P = $115.38
* Initial margin plus sale proceeds
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Regulation and Trends in Markets
¾Major regulations
– Securities Acts of 1933
– Securities Acts of 1934
– Securities Investor Protection Act of 1970
¾Trading scandals and reactions
– Sarbanes
Sarbanes-Oxley
Oxley Act
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