1. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Investments: Theory and Applications Mark Hirschey

2. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Chapter 4 (Part 2) Buying and Selling Equities

3. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Initial Public Offerings

4. 4-4 Initial Public Offerings Key Terms  Primary Market  Secondary Market  Initial Public Offerings (Ipos)  Seasoned Issue  Secondary Offerings  Private Placements  Offering Circulars  Investment Banks  Underwriter  Road Show  Firm-Commitment Offering  Best Efforts Underwriting  All-or-none Offerings  Syndicate  Underwriter’s Allotment  Dealers Agreement  Tombstone Ad  Hot IPO  Flipping Shares

5. 4-5 IPO Process  A corporation issues debt or equity securities when it needs new capital to:  Expand production facilities  Build inventories, etc  Newly issued securities are sold in the - Primary Market: the market for new securities

6. 4-6 IPO Process  All subsequent trading of those securities is done in the Secondary Market: the market for seasoned securities.  Secondary Markets involve:  The organized trading of outstanding securities on exchanges and over-the-counter markets  The NYSE, Nasdaq, the bond markets, etc. are secondary markets.

7. 4-7 IPO Process  An Initial Public Offering (IPO):  A first sale of stock or bonds to the public  Newly issued securities sold in the “Primary Market” – which is the market for new securities  Initiated by companies seeking:  Outside equity capital  A public market for their stock

8. 4-8 IPO Process  Seasoned issue: Issuance of securities for which a public market already exists  i.e. IBM sells additional stock or bonds to the general public

9. 4-9 IPO Process  Secondary Offerings: Public sale of previously issued securities held by large investors, corporations, or institutional investors.  For Example: Corporate insiders selling large blocks of stock obtained through incentive compensation plans.  Typically handled informally by securities firms and offered at a fixed price related to the current market price of the stock.

10. 4-10 IPO Process  The Difference:  In a Primary Offering: the issuing corporation receives the proceeds.  In a Secondary Offering: the issuing corporation does not receive any sale proceeds.

11. 4-11 IPO Process  Private placement: Sale to “a small group of investors”, generally under exemption of SEC and state securities registration requirements.  Small Group of Investors: assumed to be “sophisticated” or knowledgeable investors

12. 4-12 IPO Process  Some smaller companies may be exempt from:  SEC registration under Regulation A  companies raising less than $5 million in a 12-month period  Filing reports on EDGAR  Instead, these companies must file an Offering circular: special SEC filing that describes a private placement  contains financial statements and other information

13. 4-13 IPO Process  In most cases companies seeking additional investment capital hire an Investment bank: Investment backer who endorses and sponsors a company’s new securities.  Also called an underwriter  One who guarantees the purchase of stocks or bonds  Different levels: firm commitment, best-efforts, all- or-none  Act in the role of advisor and distributor

14. 4-14 IPO Process  Investment Bank Services include:  Underwriting of debt and equity securities  Advising on mergers  Acquisitions  Privatization  Restructuring  Participating in real estate  Project finance  Leasing activities

15. 4-15 IPO Process  Road Show: Series of presentations to promote company securities  Issuing companies and their investment bankers promote new issues to institutional investors (pension plans, insurance companies, mutual funds) and the general public.  Discuss the investment merits of the corporation’s securities  Drum up interest in the offering  Determine investor appetite for the firm’s securities under different pricing scenarios.

16. 4-16 IPO Process  Through this process, the issuing corporation and the investment banker come to agreement on:  Amount of capital needed by the corporation  Type of security to be issued  Price of the security to be issued  The amount of compensation (or commission) paid by the firm to the investment banker

17. 4-17 IPO Process  Two broad categories of agreements between investment bankers and issuing corporations:  Firm-Commitment Underwriting  Best-Efforts Underwriting

18. 4-18 IPO Process  Firm-commitment underwriting: Security offering in which the underwriter purchases the entire issue from the corporation and re-offers it to the general public  The investment banker guarantees to provide a certain sum of money to the corporation  Commit both reputation and investment capital  Any risk associated with failing to resell securities falls entirely on the investment bank  Typically used with large and highly respected corporations such as IBM

19. 4-19 IPO Process  Best-efforts underwriting: Security offering in which the investment banker simply agrees to make “its best effort” at selling the agreed-on amount of securities.  If the investment banker fails:  The corporation receives only the amount sold, less necessary commissions  The investment banker loses out on potential commission income but suffers no capital loss  Used with Risky startups

20. 4-20 IPO Process  A “Best-Efforts” underwriting is called an all- or-none offering when:  The underwriter agrees to do its best to sell an entire issue by a certain date  But: if all securities are not sold by that time, all money is returned to purchasers and the issue is canceled.  All-or-none offerings: Requirement for a complete sale.

21. 4-21 THE SYNDICATE  Group of underwriters  Share the risk  Syndicate manager  Underwriter’s allotment  Dealers agreement  Tombstone ads

22. 4-22 THE SYNDICATE  Many times, investment banks don’t want to take on “all” the risk of an offering so they form a Underwriting Syndicate – is group of underwriters who agree to participate in selling an issue.  Share the risk

23. 4-23 THE SYNDICATE  The lead investment bank is the Syndicate Manager  Determine the offering price  Set the timing of the issue  Respond to any deficiency letters by the SEC  Modify selling commissions  Control advertising  Control the amount of each underwriter’s allotment: the investment banker’s allocation  Responsible for the dealers agreement: contractual obligation of syndicate members.  specifies how securities dealers who are not part of the syndicate may contract to purchase some of the securities from the issue

24. 4-24 THE SYNDICATE  Tombstone Ad – An advertisement announcing a security offering (Figure 4.4 Page 139)  Name of the new issue  Number of shares offered  The offering price  List of lead investment bankers and syndicate members

25. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Regulatory Requirements

26. 4-26 SEC Regulatory Requirements Key Terms  Securities Act of 1933  Registration Statement  Filing Date  Cooling-Off Period  Preliminary Prospectus  Red Herring  Effective Date  Deficiency Letter  Final Prospectus

27. 4-27 Regulatory Requirements  Following the SEC Act of 1933, when a company makes a public offering it must file a Registration Statement: SEC document that describes an offering.  Description of the company’s main line of business  Biographical material on officers and directors  The amount of shares held by: officers, directors, and other large shareholders owning more than 10% of the company  (so-called insiders)  Complete Financial Statements  Info regarding how proceeds of the offering will be used

28. 4-28 Regulatory Requirements  The date that the investment bank submits a registration statement with the SEC is known as the filing date.

29. 4-29 Regulatory Requirements  After the registration statement has been filed, the SEC requires a cooling-off period: marketing period  period during which the issuing company and the investment banker try to drum up interest in the issue.  They do this though a Preliminary Prospectus: preliminary statement of offering characteristics.  Also called a red herring – because it has red printing across the top and in the margins  Contains much of the information from the registration statement.  Does not contain the public offering price or the effective date of the IPO

30. 4-30 Regulatory Requirements  During the cooling-off period:  The issuing company and its investment banker may not provide any other information to the investment bank’s clients beyond that which is contained in the preliminary prospectus  No firm orders can be taken  Indications of interests: Expressions of intent to buy  Are recorded as an indication of potential demand for the issue  Are a critical guide to the investment bank in its final pricing of the issue

31. 4-31 Regulatory Requirements  The public offering price is determined on the effective date after investor interest in the issues has been determined.  Effective date: Date that securities are offered to institutional investors and the general public.  If the SEC does not approve a given issue, a Deficiency Letter is issued and the effective date is postponed.:  Deficiency Letter: Disapproval notice issued by the SEC.

32. 4-32 Regulatory Requirements  Due Diligence: Required analysis  A meeting just prior to the effective date between the corporation and its investment banker to ensure that material changes have taken place between the filing date and the effective date.  Final Prospectus: Final statement of offering  Issued once the effective date arrives  The securities are sold and money is collected

33. 4-33 Regulatory Requirements  The public offering price stated on the face of the prospectus is what the general public pays.  The issuing corporation: receives a lower price determined by the agreed upon spread.  Any dealer or broker participating in the underwriting: is compensated out of the spread (the difference between what the general public pays and what the issuing corporation receives) as specified in the underwriting agreement  And other allocations

34. 4-34 Regulatory Requirements  More money was raised in 1999 than during the 1970s and 1980’s combined:  It’s reasonable to expect a slowdown in the pace of IPOs  IPO activity tends to follow dramatic growth in the overall market averages (i.e. technology boom)  Difficult market periods tend to follow active IPO markets, such as that experienced during 1998-99.

35. 4-35 Post-issue Performance of IPOs  Hot IPO – An IPO with limited shares and high demand  Previous Internet IPO’s qualified as “Hot IPOs”  Generally investment bankers allocate shares of hot IPOs to their top-performing stockbrokers and most loyal clients (i.e. commission)

36. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Individual Retirement Accounts IRAs

37. 4-37 Individual Retirement Accounts (IRAs)  Individual Retirement Accounts (IRAs): provide a powerful way to save money for retirement.  Now: $3000 contribution per person per year  Earnings inside the IRA “grow” tax free  Table: 4.10 Page 149 –Tax Deferral Benefits of IRAs are Substantial

38. 4-38 Tax Deferral Benefits of IRAs IRAs  Tax-deductible (within certain AGI limits)  Tax-deferred growth—tax collected on distributions only “New” Roth IRAs  After-tax contributions  No taxes due on distributions Education IRAs  Nondeductible contributions  Tax-free withdrawals for education purposes

39. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Taxes

40. 4-40 Tax Code Provisions  Pages 150 through 152:  Capital Gain rates  Qualified five-year Gains  Gift and Estate Tax Provisions  Exclusion for Gain on the Sale of Principal Residence

41. 4-41 Answers to Selected End of Chapter Questions and Suggested Homework  Study the following end-of- chapter questions:  1. (c)  2. (a)  4. (d) page 120  5. (d) page 122  6. (a)  7. (a)  10. (b)  11. (a)  12. (c)  13. (b)  14. (c)  15. (d)  16. (b)  18. (b)  19. (c)  20. (c)  Read the Chapter  Read the Chapter Summary  Review the Power Point Presentations