Module 6 Part 1

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  2. INVESTMENT BANKING is another name for UNDERWRITING. INVESTMENT BANKERS are firms that help corporations and municipalities raise necessary capital (money). In the case of a corporation, the money is used to fund growth and investment; in the case of a municipality, the money is used to build facilities or to improve services. The underwriting process or investment banking process matches corporations or municipalities that need money with investors who desire a return from their investment.
    If corporations or municipalities want to issue a debt security for a SHORT period of time (under 270 days), they may bring the security to market itselfOR they may have a local firm sell the security through the money market sector of the securities market.

    • If the issue is a LONG-TERM DEBT of a municipality or corporationOR if it is an equity issue for a corporation, an investment banker is retained to UNDERWRITE the issue and bring it to market. These investment bankers are also called UNDERWRITERS, and usually form what is called a SYNDICATE of other brokers/dealers to help sell the issue to investors.The two major types of underwriting commitments from the underwriter to the issuer are:
    • •Firm commitment
    • •Best efforts commitment
    A FIRM COMMITMENT UNDERWRITING involves the underwriter’s promise to sell all of the new issue. The underwriter buys the issue from the issuer and then brings it to market to sell through the syndicate.

    A variation of a firm commitment is a STANDBY UNDERWRITING. This is ONLY used in a corporate offering of stock. Under this type of commitment, the underwriter is hired by the issuing firm to sell all the shares that are left over after a rights offering.

    Remember, a rights offering is when the issuing corporation offers the new shares to existing shareholders first. Those shares not purchased by the existing shareholders in a rights offering are sold to the standby underwriter and brought to market.
  5. WHEN, AS, AND IF ISSUED stocks or bonds, commonly known as WHEN ISSUED
    Are securities that are transacted on a conditional basis. The securities have been authorized and sold to the public (issued), BUT the certificates have not been issued. When issued securities can trade in the secondary market. The settlement date for a when issued stock is a date that is set by the underwriter, or lacking such date, is a date agreed upon between the issuer and the underwriter. Full payment could be required with one-day’s written notice. The "when issued" contract is marked to the market (the price is recalculated every day the market price of the bonds change) as provided for in the when issued contract. Stock splits and Treasury securities can be issued on a when issued basis.
    • A BEST EFFORTS COMMITMENT (UNDERWRITING) for a new issue is when the issuer contacts either a single underwriter, or multiple underwriters, and asks them to sell the issue. The underwriter(s) or broker/dealers are not required to buy any shares they do not sell. The single underwriter forms a syndicate of other broker/dealers and tells the issuer that theywill do their best to sell the issue.” In a Best Efforts commitment underwriting, the issuer requires one of the following types of commitments from the syndicate:
    • •All or none
    • •“Minimum-maximum”
  7. A best efforts underwriting is usually employed for two types of issues:
    • •Debt issues by a corporate issuer, where the corporation’s ratings and credit are not very good.
    • Stock issues, especially where the outstanding stock in the marketplace is not trading very well OR the stock is a brand new issue, referred to as an INITIAL PUBLIC OFFERING (IPO).
    In an ALL OR NONE underwriting commitment, the syndicate MUST sell the entire issue OR the underwriting is cancelled because the entire amount of securities (i.e., any stocks or bonds) is not sold. This is usually required by an issuer who needs all of the money to be raised, and anything less than that amount will not help the issuer with its financial needs.

    • •If the syndicate is able to sell the entire issue, all parties are happy.
    • If the entire issue cannot be sold, the syndicate must refund all the money to the investors in the issue. In this case, the syndicate charges the issuer a fee for its efforts.
  9. In a "MINIMUM-MAXIMUM" Underwriting Commitment
    • The issuer sets BOTH a minimum and a maximum amount of securities that they must sell. This type of underwriting is used when the issuer absolutely needs a minimum amount of capital, but ideally would like a larger amount.
    • Once the minimum amount of the issue is sold, the issue is considered completed. Of course, no more than the maximum can be sold.
    • •If the minimum is not soldALL investors receive a refund.
    • •This type of underwriting is COMMON when raising capital in limited partnerships.

    All mutual funds are sold on a best efforts basis since broker/dealers do not buy any shares for their own account. Instead, they only sell what they can, which is the description of a best efforts underwriting. Usually numerous broker/dealers are involved in best efforts underwriting offerings.
  10. For every underwriting, except mutual funds:
    The MANAGING UNDERWRITER (also known as the LEAD UNDERWRITER) performs a DUE DILIGENCE review, which means that the manager researches the issuer to determine their financial health and standing in the community. Due diligence includes research into the liquidity of the issuer (LIQUIDATION VALUE), as well as the ability of its securities to perform well for investors. The purpose of due diligence is to ensure that the issue is not fraudulent OR of questionable value. The due diligence review is the responsibility of the LEAD or MANAGING UNDERWRITERS, for which they receive the manager’s fee.
    In the agreement between the issuer and the underwriter allows the underwriter to choose not to bring the issue to market if marketplace conditions were such that the issue may not be able to be sold. The clause stipulates the circumstances under which the underwriter is relieved of responsibility to bring the issue to market. Such circumstances may include sudden bankruptcy by the company OR a complete stock market crash. Under these circumstances, the issuer and the underwriter agree to withhold the issue, the underwriter is not required to forfeit the good-faith deposit, and the issuer is not held responsible for costs incurred by the underwriter. If the issuer misrepresents facts about the company or withholds critical information, the underwriter may be able to recover underwriting costs from the issuer.
  12. Providing that an investment bank broker/dealer engages in corporate and municipal underwriting, the major underwriting departments of the investment bank are:


    Handle the issuing of stock or bonds by companies that want to raise capital for use in their business.
    Handle the issuing of bonds by municipalities in the form of GENERAL OBLIGATION BONDS and REVENUE BONDS.

    GENERAL OBLIGATION BONDS are issued by municipalities and backed by the taxing power of that municipality. See Municipal Securities in Module 5 for a detailed discussion of general obligation bonds.

    REVENUE BONDS are issued by municipalities and backed by the revenues of the facility for which the bond is issued. Again, see the Municipal Securities Module for a detailed discussion of revenue bonds.
  15. All of the following are types of municipal underwriting commitments, except:
    (A) Firm
    (B) Standby
    (C) Best efforts
    (D) All or none
    FIRE Drill
  16. Answer (B) Standby. A standby underwriting is a corporate underwriting commitment when a rights offering occurs prior to securities being brought to market. All the others choices can be either corporate or municipal.
    Underwriting can be opened up to a bid process in which different investment banks compete to be the underwriter for an issue. Once the underwriter is selected (either by using the competitive OR negotiated method), the managing underwriter selects a number of other broker/dealers to assist in the selling of the issue. This group is known as the SYNDICATE or SELLING SYNDICATE.

    With large offerings by a municipality or corporation, the managers gather a group of broker/dealers that have large selling forces and form the syndicate.

    With small offerings, the managers may only include one or two other broker/dealers to be in the syndicate
  18. A syndicate is made up of two groups plus all other broker/dealers who sell the issue:
    • •The underwriter or co-underwriters (including a LEAD UNDERWRITER)
    • •The selling syndicate
    • •The selling group — the other broker/dealers
    The LEAD UNDERWRITER of the syndicate is the broker/dealer firm in the syndicate that is managing the underwriting. Accordingly, the lead underwriter is also called the SYNDICATE MANAGER. The manager is responsible for performing many functions.

    • When co-underwriters are hired to help manage a large account, one of them is designated as the lead underwriter; this firm is now in charge of all the other members of the syndicate. The lead underwriter manages the books of the underwriting account, acts on behalf of the syndicate in dealings with the issuer, and manages the entire underwriting process. Typically, one or more individuals from the lead underwriting firm manages all aspects of the underwriting, including communicating with the issuer.
    • When securities are underwritten, broker/dealers can advertise them with tombstone ad also allows underwriting firms to list their names as participants in the underwriting.

    • •The tombstone ad identifies the name of the lead underwriter at the top of the list of participating firms.
    • •If there is more than one managing underwriter, the lead underwriter is listed on the top left, beside the other broker/dealer firms.
    The SELLING SYNDICATE is composed of one or more broker/dealers who are willing to commit themselves and large sums of money to bringing the securities issue to market. These broker/dealers commit themselves financially, and they assist in the pricing of the issue. The selling syndicate uses information gathered from their sales forces on the salability of the issue to help determine marketability and a good price for the issue.

    The syndicate arranges to purchase shares or bonds from the issuer. The amount the lead underwriter allows the selling syndicate to sell is based upon the amount of financial commitment the selling syndicate makes. The lead underwriter takes the largest percentage of the issue to sell and the other members of the syndicate are allotted varying amounts, depending on their financial commitment.
    Outlines the terms under which the account will be managed, including:

    • •The amount of the issue each member is allotted
    • •The amount of money each member must contribute
    • •The basis for which the issue will be distributed in the case of being oversold
    • •The obligations of each syndicate member
    • •The type of participation under which the underwriting account will be based:

    • -An "eastern" account
    • -A "western" account
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Module 6 Part 1
2013-01-14 22:58:31
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Module 6 Part 1
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