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Private placement securities do not need to be registered with the SEC.
2. List the three types of bank participants in an underwriting syndicate and their core responsibilities, in order of compensation received, from high to low.
1. Lead Bookrunner: determine the marketing method and pricing for the transaction, highest underwriting allocation.
2. Co-Managers: provide minor input on marketing and pricing, do small underwriting allocation.
3. Selling group: don’t take on any financial risk, just sell.
A league table keeps track of underwriting participation of all banks, and is a basis for comparing different banks underwriting capabilities. League tables are important in investment banking as it is how their clients can compare them. League table leaders are more attractive when seeking an bank as an advisor.
4. Describe the function of the equity capital markets group, including the two major division they directly work with and the two types of clients they indirectly work with.
Capital market groups originate and execute capital market transactions. They work directly with client coverage bankers and the syndicate desk. They work indirectly with issuers and investors. The capital markets group basically runs between the issuers and the buyers of securities.
5. Describe the unique process utilized by Google in its IPO, including its intended advantages and potential disadvantages.
Google wanted their IPO to be done in a Dutch auction fashion. This was designed to allow for a greater distribution to retail investors, by issuing stocks to the highest bidders. This process would also avoid the some of the excess seen in an IPO. Investment bankers were concerned that this strategy would alienate the biggest clients, as they would hold no large advantage in claiming a large allocation of the IPO.
A shelf registration statement allows a company to file a single registration statement that covers multiple issues of different types of securities. Equity offerings, debt, and convertible securities can all be included in a shelf registration statement.
Equity strengthens the balance sheet. A stronger balance sheet will lead to higher ratings, and permit further funding to be available in the future using cheaper debt. A young company may want to initially strengthen their balance sheet before issuing bonds.
8. A BBB-/Baa3 rated company is looking at acquiring a smaller (but sizeable) competitor. Discuss considerations the company should take into account when deciding whether to fund the acquisition with new debt, equity, or convertible securities.
The company would want to consider 1) the cost of capital that comes with stock issuance, 2) the current state of their balance sheet (leveraged), 3) the impact on future cash flows, and 4) the EPS impact of issuing new stock and/or a convertible bond.
**9. Suppose a company issues a $180 million convertible bond when its stock is trading at $30. Assuming it is convertible into 5 million shares, what is the conversion premium of the convertible?
Proceeds/# of Shares=Conversion Price
(Conversion Price-Current Price)/Current Price=Conversion Premium
$180 million/5 million=$36
20% Conversion Premium
*10. How many shares will be issued by a convertible issuer if conversion occurs for a $200 million convertible with a conversion premium of 20%, which is issued when the issuer’s stock price is $25? (Show calculations.)
Current Price*(1+Premium)=Conversion price
Proceeds/Conversion Price=# of Shares
$200 million/$30=6.67 million
11. Why did the SEC delay declaring Google’s IPO registration effective?
The SEC did not elaborate on the delay in declaring Google’s IPO. Assumptions have been made that the delay in declaring Google’s IPO registration effective was likely due to there being an issue or error in the paperwork.
12. Provide reasons that an investment bank might give to support their advice that a private company should “go public.”
Reasons for taking a company public include: 1) access to the public market, 2) enhanced profile and marketing benefits, 3) creation of an acquisition currency and compensation vehicle, 4) liquidity for shareholders.
1) strong stock performance or supportive equity research, 2) large insider holding or small float/illiquid trading, 3) overly leveraged capital structure, 4) strategic event: finance acquisition or large capital expenditure, 5) sum of the parts analysis indicates hidden value, 6) investor focus.
Best efforts transactions is where the bank buys the entire issue at a discount, and then tries to resell at a higher price. The gross spread represents the compensation for the bank taking on the risk. A bought deal is when the bank buys the whole transaction at a specified price, and again, tries to sell at a higher price to other investors. The difference between these two transaction who bears the risk. In a best efforts transaction, the issuer bears the risk, and it a bought deal, the bank bears the risk.
**15. What are some methods used by investment banks to help equity issuers mitigate price risk during the marketing process?
To mitigate price risk during the marketing process by filing a registration statement. The prospectus portion of this filing notes a share price range. During the marketing process, a red herring prospectus is shown during the marketing period to display pricing during this process.
A green shoe option gives an investment bank the right to sell short 15% of the shares the bank is underwriting. This creates a “naked” short position. Shares need to be bought following the initial offering.
17. When a company has agreed to a green shoe, who does the underwrite buy shares from if the share price drops? Who do they buy shares from if the share price increases?
If the share price drops, the bank will buy shares from the market. If the price increases, the bank will buy shares from the issuer. This feature is intended to stabilize the price of an equity following its initial placement in the market.
*18. Calculate the investment bank’s fees and profit for a 5 million share equity offering a at $40/share, with a 15% green shoe option (fully exercised) assuming a 2% gross spread, assuming the issuer’s share price decreases to $38/share after the offering.
5 million * $40 = $200 million * 2% = $4 million
(5 million * 15%) * $40 = $30 million
(5 million * 15%) *$38 = $28.5 million
$30 million - $28.5 million = $1.5 million
=1.5 million + $4 million = $5.5 million
1. After an initial hedge is in place, what do hedge fund investors in convertible bonds do with shares of the underlying stock when the stock price increases or decreases?
As the share price decreases, the investor will buy more shares to cover their short position. If the price of the underlying stock price increases, the investor will borrow more shares to sell short. The strategy is to maintain the hedge ratio, which is equal to the risk-neutral probability. As the stock price fluctuates, the investor adjusts his position accordingly.
2. True or false: Convertible arbitrage hedge funds invest in convertible bonds because the fund managers have a bullish view on the company’s stock. Explain your answer.
Neither. The appeal of a convertible arbitrage strategy is that it is market neutral. It is a strategy that should have good results in either a bull or a bear market.
3. Discuss whether you feel the SEC’s temporary ban on short-selling financial stocks in 2008 during the financial crisis unfairly punished convertible arbitrage funds.
Investors using a convertible arbitrage strategy execute their strategy by buying convertible bonds, and short selling shares of the same company. The ban the SEC placed on short-selling stocks during the financial crisis would have had an impact on these funds, but I don’t know if fairness really applies.
**I’m not sure my thinking is correct on this one**
4. If companies A and B are identical in every respect except B has higher stock price volatility, which company would likely achieve better convertible pricing? Assuming convertibles issued by A and B have the same terms except for conversion price, would the company you selected have a higher or lower conversion price?
The conversion price determines the number of shares that the investor has the right to convert to. The stock with the higher volatility is likely to achieve better convertible pricing as volatility increases value creating opportunities. Investors participating in convertible securities are typically hedge funds, and plan on making money from the change in the underlying stock price. Stock B would have the higher conversion price.
5. WheelCo is raising $200 million via a mandatory convertible bond issuance. Assuming the company’s share price on the date of issuance is $20 and the convertible bond carries a 25% conversion premium, what is the number of shares WheelCo has to deliver to investors if its share price at maturity is (a) $19; (b) $22; (c) $26; and (d) $30?
$200 million/$25=8 million shares.
The value of these shares at would be at (a) $152 million, (b) $176 million, (c) $208 million, and (d) $240 million.
6. Suppose you are a current shareholder in a company that is contemplating capital raising alternatives. Assuming the transaction would have no negative credit repercussions and you want minimal EPS dilution, rank the following types of convertibles from least potential for dilution to most potential for dilution: coupon-paying convertible, mandatory convertible, zero coupon convertible.
Zero coupon would hold the least risk for dilution, as there is lower probability of these bonds converting into common shares, unless the value exceeds the principal cash redemption, which increases each year. As not many investors exercise the conversion option, these bonds hold the least EPS dilution risk.
Coupon-paying convertibles would be the next most potentially dilutive, because if the price is above the conversion price, most investors will prefer to convert to stock. However, if the price is below that of the conversion price, it would not be as dilutive to EPS.
Mandatory convertibles would be the most potentially dilutive as there is a mandatory conversion at maturity. New shares would enter the market and dilute the EPS.
7. A U.S.-based BBB-rated company is looking to make a large acquisition. Management believes synergies from the acquisition will create new market opportunities. Unfortunately, these new opportunities will take a few years to realize, and until then, benefits will not be fully reflected in the company’s stock price. If the company has rating agency concerns and wants tax deductions from interest payments, what type of security is this company likely to issue in support of its acquisition and why?
The company could use a zero coupon convertible security, as issuers of these bonds are able to take tax deductions in relation to annual accretion. This allows a company to raise cash without having to pay out actual coupons. A coupon-paying convertible would also allow for tax deductions for an interest expense.
8. Why was the Nikkei Put Warrant program so profitable for Goldman Sachs?
Nikkei put warrants were futures based on the Japanese stock market. Goldman was able to buy the warrants at a price below their theoretical value, making a opportunity for future profit. Goldman used “delta hedging” by buying more futures when the Japanese stock market would decline, and selling when the Japanese stock market would rise, creating a profit for themselves.
9. What is ASR an abbreviation for? Describe this transaction and the principal benefit for a client. What additional benefit did IBM achieve in the ASR program described in this chapter?
ASR stands for accelerated share repurchase program. An ASR transaction goes as follows: 1) Company buys shares from an investment bank with a cash adjustment to follow. 2) The investment bank borrows these shares from current shareholders. IB covers shares through daily open market purchases. 3) When position is covered, if the total cost of IB is higher than the payment, the company reimburses the IB. If the total cost is lower, the IB reimburses the company. The principal benefit for the client is a rapid and positive impact on EPS.
**Not sure on this one either**
10. Assume a company’s ADTV is 240,000 shares. how many days would it take to complete a 10.8 million share repurchase program? The company has 120 million shares outstanding, and its estimated EPS for the current fiscal year is $3.40. Assuming the company meets its earnings estimate, what would year-end EPS be under an ASR program for the full 10.8 million shares, assuming it is executed 20 business days before the company’s fiscal year end? And under an open market repurchase program?
120 million-10.8 million=109.2 million
$408 million/109.2 million=$3.73/share
10.8 million/60,000=180 days
120 million*$3.40=$408 million
120 million-(60,000*20)=118.8 million$408 million/118.8 million=$3.43/share
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