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?