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What defines a private placement market?
The limited number of investors
In a private placement market (both debt and equity), what does an investment banker do?
Acts as finder -- matches buyers with sellers
What are the two types of organized private markets?
equity market and debt market
What is a private equity market?
where small, unseasoned firms seek first outside investment
What is a venture capitalist?
- initial outside investor in a business
- operates in both private markets
- high risk high return business
What does unseasoned mean?
firm has not sought outside financing before
Why do small, unseasoned firms need venture capitalists?
- 1) no one else wants to invest in small, unseasoned firms
- 2) firms have no historical records of operating results
- 3) firms have extremely uncertain growth projection
Why do venture capitalists invest in unseasoned companies?
- 1) to keep or acquire intellectual capital
- 2) to keep or acquire new technology
In the private equity market, where does the money come from?
What do venture capitalists get in return for the investment (besides monetary reasons)?
seats on the Board of Directors of the company they invest in
Besides individuals, who else can be a venture capitalist?
large seasoned companies usually have a venture capital subsidiary
What usually happens when venture capitalists get on the Board of a small unseasoned company?
minority position, but take over as soon as firm stumbles
Is venture capital money related to the US economy?
Yes -- it is directly related
What is a primary market?
where securities are sold for the very first time
What is a secondary market?
where securities are bought and sold for the second and subsequent time
What does a money market deal with?
financial instruments with a maturity of less than 1 year
What does a capital market deal with?
financial instruments with a maturity of more than 1 year
Except organized exchanges, all financial markets are ___
over the counter markets
What does ECN stand for and what is it?
- electronic communication network
- telecommunication network without physical location, provides information (quotes), but there is no trading
What is the disadvantage of over the counter markets?
not as continuous as organized exchanges, trades happen less often
What is a broker?
- finder of buyers and sellers
- does not hold securities in own account
What is a dealer?
- finds buyers and sellers
- does hold inventories of securities
Where are over the counter markets located?
wherever the dealer or broker is, not one set physical location
What are the characteristics of organized exchanges (3)?
- 1) they have a physical location
- 2) they are registered with the SEC
- 3) they are auction markets (must have buyers and sellers, which have to be matched)
What are the benefits of organized exchanges (3)?
- 1) continuous market = securities trade more often
- 2) establish and publish relatively fair security prices (prices consider all public information available)
- 3) they are extremely helpful in helping firms raise new capital
What are some listing requirements for organized exchanges?
- size of the firm (assets, revenue, etc)
- market value
- public ownership
What is an investment banker?
financial specialist who serves as intermediary in the selling of securities, can be individual or firm (Goldman-Sachs, Merill-Lynch)
What are the 3 functions of an investment bank(er)?
- 1) to underwrite a security's issue (buy from firm then sell to first buyer on primary market)
- 2) to distribute securities (syndicate is wholesaler, dealer's organization is retailer)
- 3) to advise buyers and sellers
What is a syndicate in relation to financial markets?
group of investment bankers
When and why is a syndicate formed?
when issuing new securities to spread the risk between the investment bankers
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
Explain the direct sale distribution method for new issues of securities.
- no investment banker involved
- issuer sells directly to the first buyer
What is the disadvantage of using the direct sale method of securities distribution?
lower issuing costs
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
What is the underwriting spread?
difference between the current market price and the price issuer pays investment banker
What is the advantage of using the negotiated purchase method of securities distribution?
advice from banker included
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
Who must use the competitive bid purchase distribution method for new issues of securities?
- public utilities
- state and municipal governments
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
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
When is the best efforts or commission basis offering method used?
with smaller, riskier, more speculative issues
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
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
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
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
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
What does rights on mean?
buy the share including the right to get new shares at the subscription price
What does ex-rights mean?
buy the share without the right to get new shares at the subscription price
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?
How do you calculate the amount of new shares to be issued?
- amount to be raised
- subscription price
How do you calculate the amount of rights needed for 1 new share?
- amount of old shares
- amount of new shares
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]
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
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)
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
What is a standby agreement?
offer to buy all left-over shares of after a rights offering
What is a private debt market?
where seasoned firms sell additional debt
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
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
What are the disadvantages of a private placement debt market?
- interest cost higher
- more restrictive protective covenants
- possible future regulation by SEC (highly unlikely)
What are floatation costs?
- issuing costs
- include fees for lawyers, accountants, trustees, administration etc
What is the biggest issuing cost?