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What are the 5 distribution methods for new issues of securities?
- 1. negotiated purchase
- 2. competitive bid purchase
- 3.best efforts or commission basis offering
- 4. privileged subscription
- 5. direct sale
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Explain the direct sale distribution method for new issues of securities.
no investment banker involved, issuer sells directly to the first buyer
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What is the disadvantage of using the direct sale method of securities distribution?
lower issuing costs
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Explain the negotiated purchase distribution method for new issues of securities.
- most profitable for investment banker
- most used method
- investment banker and issuer negotiate price
- has underwriting spread
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What is the underwriting spread?
difference between the current market price and the price issuer pays investment banker
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What is the advantage of using the negotiated purchase method of securities distribution?
advice from banker included
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Explain the competitive bid purchase distribution method for new issues of securities.
several syndicates bid on an issue of securities, highest bidder gets the sale
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Who must use the competitive bid purchase distribution method for new issues of securities?
- railroads
- public utilities
- state and municipal governments
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What is the advantage and disadvantage of using the competitive bid purchase method of securities distribution?
- + higher price for the issuer
- - no advising from investment banker
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Explain the best efforts or commission basis offering method for distribution of new issues of securities.
- investment banker takes securities on commission (does NOT buy or underwrite them)
- makes best efforts to sell securities
- unsold securities go back to issuer
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When is the best efforts or commission basis offering method used?
with smaller, riskier, more speculative issues
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Explain the privileged subscription method for distribution of new issues of securities.
new securities are first offered to existing holders of securities for a price that is lower than the current market price
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What is a different name for the privileged subscription method and why?
- rights offering
- one right to buy new shares at below market price per currently held share of common stock
- amount of rights needed per new share depends on terms of the offering
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What do the terms of a rights offering specify?
- number of rights necessary to get 1 new share
- subscription price per new share
- expiration date of rights offering
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What can be done with the right to buy new shares at the subscription price?
- exercise the right and buy new shares
- sell the rights
- let the right expire and forego the cash value
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How are securities traded that include a rights offering around the date of the offering?
up to 2 days before they trade rights on, then they are traded ex-rights
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What does rights on mean?
buy the share including the right to get new shares at the subscription price
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What does ex-rights mean?
buy the share without the right to get new shares at the subscription price
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What are the three questions that have to be answered to calculate the value of a right to buy new shares at the subscription price?
- 1) How many rights are required for 1 new share?
- 2) What effect does the rights offering have on the price of the stock?
- 3) What is the value of 1 right?
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How do you calculate the amount of new shares to be issued?
- amount to be raised
- /
- subscription price
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How do you calculate the amount of rights needed for 1 new share?
- amount of old shares
- /
- amount of new shares
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How do you calculate the price of the shares after the new one have been issued (the effect of the offering on the stock price)?
- [(amount of old shares x issue price)
- + (amount of new shares x subscription price)]
/
- [amount of old shares
- + amount of new shares]
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How do you calculate the value of one right to buy new shares at the subscription price?
- [new price per share - subscription price per share]
- /
- amount of rights needed for 1 new share
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What are the 2 alternative equations to calculate the value of 1 right to buy new shares at the subscription price?
r = (Mo - S) / (N - 1)
or
r = (Me - S) / N
- r = value of one right
- Mo = market price right on
- Me = market price ex-right
- S = subscription price
- N= number of rights needed to buy 1 new share
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What is a standby agreement?
offer to buy all left-over shares of after a rights offering
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What is a private debt market?
where seasoned firms sell additional debt
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Who are the 3 major investors on the private debt market?
- 1) life insurance companies
- 2) state and local retirement funds
- 3) private pension funds
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What are the advantages of a private placement debt market?
- speed (no SEC approval needed)
- reduced floatation cost (no underwriting or distribution cost)
- financial flexibility
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What are the disadvantages of a private placement debt market?
- interest cost higher
- more restrictive protective covenants
- possible future regulation by SEC (highly unlikely)
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What are floatation costs?
- issuing costs
- include fees for lawyers, accountants, trustees, administration etc
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What is the biggest issuing cost?
underwriting spread
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