1. Chapter 14. Primary Markets
Traditional Process
Regulation
Variations in Underwriting

2. Background all types of securities
security being sold for the first time
new offerings of firms with publicly held securities
-- SEO seasoned equity offering
IPOs
after initial offering, security is in secondary market

3. I. Traditional Process investment banks play key role
function performed by different institutions
roles:
(1) advising
(2) underwriting/best efforts
(3) distribution & support

4. (1) advising
timing of offering
terms of security
pricing
regulation

5. (2) underwriting optional investment bank buys securities from issuer,
then resells to public
investment bank bears the price risk

6. price set 2 days prior to issue
security floatation
firm commitment
resale price - guaranteed price
= gross spread
= underwriter’s discount

7. size of discount depends on
type of security
-- bonds lowest, stock IPOs highest
size of issue
-- smaller issues have larger discount
market conditions
.5% - 7% (table 14-1)

8. group of investment banks
several investment banks bear price risk
lead underwriter
-- bulge bracket firm
syndicates help underwrite
selling group
syndicate AND
other firms
-- help sell issue, do not underwrite

9. tombstone advertisement lists all of the underwriters details of issue
after sale has taken place
to get more underwriting business

11. IPOs typically underpriced
1980s: first day return 7%
: 15%
: 65%
why?
reduces risk for underwriter
issuer accepts underpricing for
prestigious underwriter

12. who gets “hot” IPOs? Lucent 1996 Red Hat 1999 (Linux) “spinning”
underwriters allocate shares to preferred customers

13. (2) best efforts placement
alternative to underwriting
investment bank promises to use “best efforts” to sell issue
but no guarantee of price
-- issuer retains price risk
done with firms with limited market recognition

14. (3) distribution & support
underwriters expected to support secondary market
hold large inventory of securities

15. who underwrites? commercial banks, insurance co.
U.S. firms restricted under Glass Steagall until 1999
no restrictions on firms outside U.S.

16. securities houses
top ten underwriters do over 75% of underwriting
also leading brokerage firms and dealers

17. top underwriters, 2003 Equity & bonds 1. Citigroup 2. Merrill Lynch
3 . Morgan Stanley

21. II. Regulation SEC regulates primary market disclosure of information
insider trading

22. security registration w/ SEC
prospectus
nature of firm
features of security
risk
firm management
certified financial statements

23. firms liable for incorrect info
criminal and civil
underwriters possibly liable
must show due diligence in reviewing info

24. red herring waiting period for SEC approval
firm distributes preliminary prospectus
saying so in red ink
red herring

25. SEC approval registration is effective SEC determines info is complete
NOT accurate
NOT a recommendation
investment bank now offers security for sale

26. Shelf registration rule
SEC rule 415 (1982)
issuer gets prior approval for several new issues w/in 2-year period
investment grade
NOT IPOs
allows issuer to move quickly when market conditions favorable

27. Exempt from registration
U.S. government debt
municipal debt
commercial paper
small offerings (< $1 million)
intrastate offerings

28. III. Variations in Underwriting
Bought Deal
investment bank presents offer to firm to buy entire block of debt securities
-- issuer accepts/rejects w/in days
-- if accepts, issuer “bought the deal”

29. only 1 underwriter
-- greater risk of capital
-- issue usually presold to institutional buyers

30. Competitive bidding
auction
issuer sets terms of issue,
places up for bid to competing underwriters
-- competition will lower cost
required for municipalities, utilities
no evidence that this is cheaper

31. Pre-emptive Rights Offering
company w/ stockholders
new stock offered to existing shareholders
-- below market value
-- prevents dillution of voting rights

32. Private Placement
issued placed directly with small # of buyers
no solicitation/advertising to public
buyers are institutional investors
-- insurance co., pension funds
-- capable of evaluating risks

33. usually bonds
no registration w/ SEC
-- but must offer prospectus
PP are less liquid
-- limits on resale for 2 years

34. Growth in private placements
rule 144A (1990)
-- allows trading of PP among institutions