Deck 19: Equity Financing

Question 1

A group of investment bankers who pool their efforts to underwrite a security are known as a(n):

A)amalgamate.
B)conglomerate.
C)green shoe group.
D)klatch.
E)syndicate.

Answer 1

syndicate.

Question 2

Under the _____ method, the underwriter buys the security for less than the offering price and accepts the risk of not selling the issue, while under the _____ method, the underwriter does not
Purchase the shares but merely acts as an agent.

A)best efforts; firm commitment
B)firm commitment; best efforts
C)general cash offer; best efforts
D)competitive offer; negotiated offer
E)seasoned; unseasoned

Answer 2

firm commitment; best efforts

Question 3

Potential investors learn of the information concerning the firm and its new issue from the:

A)pre-underwriting negotiating meeting.
B)red herring.
C)letter of commitment.
D)emails from their former finance professor.
E)rights offering.

Answer 3

red herring.

Question 4

An equity issue sold to the firm's existing shareholders is called:

A)a rights offer.
B)a general cash offer.
C)a private placement.
D)an underpriced issue.
E)an investment banker's issue.

Question 5

During the stock exchange waiting period the potential issuing company can issue a preliminary prospectus which contains:

A)exactly the same information as the final prospectus except and indication of stock
Exchange approval.
B)all the information as the final prospectus including red writing stating it is a red herring.
C)very limited financial information and red writing stating it is preliminary.
D)only a description of what the funds are to be used for.
E)information very similar to the final prospectus without a price nor with stock exchange
Approval.

Question 6

The winner's curse is used to describe:

A)the payoff you receive on lottery tickets.
B)the behavior of the informed investor and why some IPOs have such a large initial return.
C)acquiring all underpriced IPO issues.
D)a fully underwritten issue.
E)None of the above.

Question 7

Empirical evidence suggests that new equity issues are generally:

A)priced efficiently by the market.
B)overpriced by investor excitement concerning a new issue.
C)overpriced resulting from stock exchange regulation.
D)underpriced, in part, to counteract the winner's curse.
E)underpriced resulting from stock exchange regulation.

Question 8

Management's first step in any issue of security to the public is:

A)to file a registration form with the stock exchange.
B)to distribute copies of the preliminary prospectus.
C)to distribute copies of the final prospectus.
D)to obtain approval from the board of directors.
E)to prepare the tombstone advertisement.

Question 9

The first public equity issue made by a company is a(n):

A)initial private offering.
B)initial public offering.
C)stock exchangeondary offering.
D)seasoned new issue.
E)None of the above.

Question 10

A registration statement is effective on the 20th day after filing unless:

A)the stock exchange is backlogged with statements.
B)a tombstone ad is issued indicating its demise.
C)a letter of comment suggesting changes is issued by the stock exchange.
D)a syndicate can be formed sooner.
E)None of the above.

Question 11

The first public equity issue that is made by a company is referred to as:

A)a rights issue.
B)a general cash offer.
C)an initial public offering.
D)an unseasoned issue.
E)Both C and D.

Question 12

Companies use tombstone advertisements in the financial press to:

A)announce the death of the company.
B)announce the failure of a financial strategy.
C)announce the availability of a new issue of a corporate stock.
D)notify the public of foreclosure.
E)None of the above.

Question 13

A rights offering is:

A)the issuing of options on shares to the general public to acquire stock.
B)the issuing of an option directly to the shareholders to acquire stock.
C)the issuing of proxies which are used by shareholders to exercise their voting rights.
D)strictly a public market claim on the company which can be traded on an exchange.
E)the awarding of special perquisites to management.

Question 14

In a best efforts offering the investment banker makes their money primarily by:

A)earning the spread between the buying and offering price.
B)earning a commission on each share sold.
C)earning the discount between the buying and offering price.
D)charging a flat fee for all services.
E)None of the above.

Question 15

The green shoe option is used to:

A)cover oversubscription.
B)cover excess demand.
C)provide additional reward to the investment bankers for a risky issue.
D)provide additional reward to the issuing firm for a risky issue.
E)Both A and B.

Question 16

Investment banks perform which of the following services for corporate issuers.

A)Formulating the method used to issue the securities.
B)Pricing the new securities.
C)Selling the new securities.
D)Provide green shoe provision.
E)All of the above.

Question 17

Professor Jay Ritter found best-efforts offerings are:

A)reserved for the premier customers because they deserve 'best-efforts'.
B)used most often with seasoned equity issues.
C)used with small IPO issues.
D)attractive because of price stability.
E)None of the above.

Question 18

A firm commitment arrangement with an investment banker occurs when:

A)the syndicate is in place to handle the issue.
B)the spread between the buying and selling price is less than one percent.
C)the issue is solidly accepted in the market evidenced by a large price increase.
D)the investment banker buys the security for less than the offering price and accepts the
Risk of not being able to sell them.
E)the investment banker sells as much of the security as the market can bear without a price
Decrease.

Question 19

A new public equity issue from a company with equity previously outstanding is called a(n):

A)initial public offering.
B)seasoned equity issue.
C)unseasoned equity issue.
D)private placement.
E)syndicate.

Question 20

Which of the following is not normally an example of the services offered by investment bankers?

A)Aiding in the sale of security.
B)Facilitating mergers.
C)Acting as brokers to both individuals and institutional clients.
D)Offering checking accounts to corporations.
E)Both C and D.

Question 21

The reputational capital of investment bankers is based on their roles as intermediaries with more in-depth knowledge of the issuer.Investment bankers maintain their reputation by:

A)certifying the issue.
B)monitoring the issuing firm's management and performance.
C)pricing issues fairly.
D)marketing and bearing risk.
E)All of the above.

Question 22

The offering price is set to make the issue attractive to the market and provide a good price to the issuer.Which of the following is/are true?

A)Empirical studies by Ritter have shown that the average firm commitments are over-priced
On the first day of trading.
B)Empirical studies have shown that the best efforts sales have over-pricing on the first day
Of trading.
C)Some issues such as Shiva which rose dramatically on the first day of trading were viewed
As successfully priced by the underwriter because it helped build a short-term investment
Base.
D)Empirical studies have shown that the average firm commitments are under-priced on the
first day of trading.
E)None of the above.

Question 23

The key differences between a negotiated offer and a competitive offer is that:

A)the underwriters can not set the spread in a negotiated bid but can in a competitive offer.
B)the issuing firm can offer its security to the highest bidder in a competitive bid but in a
Negotiated bid only one investment banker is used.
C)the issuing firm work the underwriter for the best spread in a negotiated bid which will be
Less than available in a competitive offer.
D)the underwriter will not do a full investigation in negotiated bid because the company is at
Their mercy while in a competitive bid the underwriter must be extra diligent.
E)None of the above.

Question 24

A study by Lee, Lockhead, Ritter and Zhao in examining the underwriting discount and other direct costs of going public with a debt or equity offering found:

A)the direct expenses are higher for equity than debt offerings.
B)substantial economies of scale are prevalent.
C)underpricing on average is similar in magnitude to total direct expenses.
D)overpricing on average is similar in magnitude to total direct expenses.
E)All of the above.

Question 25

Which of the following statements is true?

A)The subscription price is generally above the old share price.
B)The subscription price is generally above the ex-rights price.
C)The subscription price is generally below the old share price.
D)Both A and B.
E)Both B and C.

Question 26

A standby underwriting arrangement provides the:

A)company with methods to cancel the offering.
B)company with an alternate investment banker if there is conflict between the issuer and
The agent.
C)investment banker with an oversubscription privilege to ensure profits are earned.
D)company with an alternative avenue of sale to ensure success of the rights offering.
E)investment bankers with an added syndication for the rights offering.

Question 27

Corporations use the shelf registration method of security sales because:

A)preregistered security can be quickly brought to market.
B)the main registration process is eliminated for up to two years.
C)their stock is below investment grade.
D)Both A and B.
E)Both B and C.

Question 28

To determine the value of a rights offering, the shareholder needs to know what two pieces of information in addition to the current share price:

A)the subscription price and the number of rights needed to acquire a new share.
B)the amount of new equity to be raised and the number of rights needed to acquire a new
Share.
C)the amount of new equity to be raised and standby fee.
D)the detachment date and the subscription price.
E)None of the above.

Question 29

Arguments to explain why most equity issues are underwritten versus sold through a rights offering are:

A)Underwriters buy at an agreed upon price and bear some risk of selling the issue.
B)Cash proceeds are available sooner in underwriting and the issue is available to a wider
Market.
C)Investment bankers can provide market advice and certify the issue for potential investors.
D)Underwriting is cheaper than rights issue.
E)All of the above.

Question 30

Debt capacity is given as a reason when the value of the equity falls when follow on equity issue is announced.The reason for this is:

A)the high issue costs of a debt offering must be paid by the shareholders.
B)the priority position of the equity is lowered.
C)the management has information that the probability of default has risen, limiting the debt
Capacity causing the firm to raise equity capital.
D)the management knows that the equity is underpriced.
E)None of the above.

Question 31

If a shareholder or investor wants to acquire new equity under a rights plan they must:

A)acquire new equity in the market to get a controlling fraction of shares to be eligible for
Rights.
B)simply pay a registration fee and turn in the subscription price.
C)acquire the correct rights per share desired, turn the rights and the total subscription price
Into the subscription agent.
D)acquire the correct rights and wait for the company to send you the shares.
E)call their broker and sell some CBOE options to make any money.

Question 32

In comparison to debt issuance expenses the total direct costs of equity issues are:

A)considerably less.
B)about the same.
C)meaningless.
D)considerably greater.
E)None of the above.

Question 33

Assuming everything else is constant, when an equity goes ex-rights its price should:

A)decrease since the shareholder is losing an option.
B)increase since the corporation no longer has the right to force the shareholder to convert.
C)remain the same since an efficient market would anticipate this change.
D)move up or down depending on whether a small investor wanted to exercise his/his rights.
E)None of the above.

Question 34

Underpricing can possibly be explained by:

A)oversubscription of an issue.
B)strong demand by investors.
C)undersubscription of an issue.
D)Both B and C.
E)Both A and B.

Question 35

Empirical evidence suggests that upon announcement of a new equity issue, current share prices generally:

A)drop, perhaps because the new issue reflects management's view that ordinary equity is
Currently overvalued.
B)remain about the same since an efficient market anticipates a new equity issue.
C)increase, perhaps because the issues are associated with positive NPV projects.
D)increase, because the market supply is always less than demand.
E)increase, because underwriters exercise their green shoe option.

Question 36

The six components that make up the total costs of a new issues are:

A)the spread; other direct expenses such as filing fees; indirect expenses such as
Management time; economies of scale; abnormal returns and the Green Shoe option.
B)the discount; other direct expenses such as filing fees; indirect expenses such as
Management time; due diligence costs; abnormal returns and the Green Shoe option.
C)the spread; other direct expenses such as filing fees; indirect expenses such as
Management time; abnormal returns; underpricing and the Green Shoe option.
D)the spread; other direct expenses such as filing fees; economies of scale; due diligence
Costs; abnormal returns and underpricing.
E)None of the above.

Question 37

A shareholder who has rights:

A)is not always better off to exercise the rights.
B)is not always better off to sell the rights into the market.
C)can exercise their rights or sell them.
D)is never in the same ownership position again with rights.
E)None of the above.

Question 38

Professor Clifford W.Smith, in evaluating issuance costs from underwritten issues, rights issues with standby underwriting and a pure rights issues found that 90% of the issues are underwritten which
Was the most expensive method.This is done because:

A)investment bankers know more than CFOs and they may buy the issue at an agreed price
And disburse the funds sooner.
B)investment bankers can increase the price received by increasing confidence in the issue,
They will buy the issue at an agreed upon price and disburse the cash sooner.
C)investment bankers provide other services including price counsel, increase public
Confidence and provide funds to the issuer sooner.
D)investment bankers know how to price the issue, would not need to set as low as a price
As the subscription price and provide price counsel.
E)None of the above.

Question 39

The diagonal listing of investment bankers on tombstone advertisements reflects their ____ relative to the other investment bankers listed below.

A)prestige
B)ability to manage selling syndicates
C)role as a firm commitment buyer
D)role as a best efforts seller
E)None of the above.

Question 40

In terms of costs of issuing equity, Professor Clifford W.Smith finds that the ranking of methods, from cheapest to most expensive, is:

A)rights issue with standby underwriting, equity issue with underwriting, pure rights issue.
B)pure rights issue, rights issue with standby underwriting, equity issue with underwriting.
C)pure rights issue, preferred stock and debt issue with underwriting for an IPO, rights issue
With standby underwriting.
D)equity issue with underwriting, rights issue with standby underwriting, pure rights issue.
E)equity issue with underwriting, pure rights issue, rights issue with standby underwriting.

Question 41

The Direct Interactive Publishing Company is planning to raise €200 million euros in new capital. There are currently 50 million shares outstanding with an estimated market price of €60 each.The corporate officers are debating whether to use a rights offering (with or without a standby underwriting) or have the issue fully underwritten.The company is currently listed on a regional exchange and plans to list on a national exchange after the security issue. List and explain three advantages/disadvantages of each method.

Question 42

Venture capitalists provide financing for new firms from the seed and start-up stage all the way to mezzanine and bridge financing.In exchange for financing entrepreneurs give:

A)a high interest rate debt instrument and control.
B)an equity position and usually board of director positions.
C)up the right to have an initial public offering.
D)control to a court appointed trustee.
E)hire the venture capitalists as CEOs and CFOs.

Question 43

Which of the following is not one of the four main functions that underwriters provide?

A)Risk bearing.
B)Marketing.
C)Auditing the financial statements.
D)Certification.
E)Monitoring.

Question 44

The market for venture capital refers to the:

A)private financial marketplace for servicing small, young firms.
B)bond markets.
C)market for selling rights to individuals who already own shares.
D)market for selling equity security for firms with equity already outstanding.
E)None of the above.

Question 45

The Wordsmith Corporation has 10,000 shares outstanding at €30 each.They expect to raise €150,000 by a rights offering with a subscription price of €25 how many rights must you turn in to
Get a new share?

A)0.60
B)1.20
C)1.67
D)2.00
E)Insufficient data to determine.

Question 46

The Holyoke Corporation has 120,000 shares outstanding with a current market price of €8.10 per
share.The company needs to raise an additional €36,000 to finance new expenditures, and has
decided on a rights issue.The issue will allow current shareholders to purchase one additional
share for 20 rights at a subscription price of €6 per share.
If the ex-rights price were set at €7.90, would you as a potential new shareholder choose to buy
shares ex-rights or buy shares at the old price and exercise your rights?

Question 47

An IPO of a firm formerly financed by venture capital is carried out for what primary purposes?

A)Insiders can sell their shares or cash out.
B)Generate cash to pay down bank indebtedness.
C)To establish a market value for the equity and provide funds for operations.
D)Firms financed by venture capital do not issue an IPO.
E)All of the above.

Question 48

Consider the following two statements: (i) In a shelf cash offer, can elect to award the underwriting contract through a public auction instead
Of negotiation.
(ii) A standby rights issue is the same as a pre-emptive rights issue, except that the net proceeds are
Guaranteed in the latter.

A)(i) is correct, (ii) is incorrect.
B)(i) is incorrect, (ii) is correct.
C)Both (i) and (ii) are correct.
D)Both (i) and (ii) are incorrect.
E)(ii) is incorrect, (i) is correct if the auction is private.

Question 49

Assuming everything else is constant, if a share's old price is €25 and the ex-rights or new share price is €19, then the value of the right is:

A)€-6.
B)€ 6.
C)Impossible to determine without the subscription price.
D)Impossible to determine without the number of rights needed to buy one share.
E)None of the above.

Question 50

The LaPorte Corporation has a new rights offering, you can buy one share with 3 rights and €20 per share.The stock is now selling ex-rights for €26.The price rights-on is:

A)€22.00
B)€24.00
C)€26.00
D)€28.00
E)Impossible to determine without the cum-rights price.

Question 51

The evidence on IPO sales is varied from issue to issue, but there are three common themes;
underpricing, underperformance, and the reasons for going public.Explain these three themes.

Question 52

Regional Power wants to raise €10 million in new equity.The subscription price is €20.There are currently 3 million shares outstanding, each with 1 right.How may rights are needed to purchase 1
Share?

A)1
B)3
C)5
D)6
E)8

Question 53

Arguments against the use of the shelf-registration are:

A)only technology and manufacturing-based firms can use it.
B)master registration statement up to two years old limits the timeliness of disclosure.
C)possible market overhang from future issues depressing price.
D)Both A and C.
E)Both B and C.

Question 54

The Holyoke Corporation has 120,000 shares outstanding with a current market price of €8.10 per share.The company needs to raise an additional €36,000 to finance new expenditures, and has decided on a rights issue.The issue will allow current shareholders to purchase one additional share for 20 rights at a subscription price of €6 per share. Suppose that the company was also considering structuring the rights issue to allow for an additional share to be purchased for 10 rights at a subscription price of €3.Prove that a shareholder with 100 shares would be indifferent between purchasing a new share for 10 rights at €3 or purchasing a new share for 20 rights at €6.

Question 55

The Overland Corporation intends to issue 50,000 new shares to raise funds for expansion of current plant facilities.The current share price is €40 and there are 500,000 shares outstanding.
The number of rights needed to buy a share should be:

A)1
B)10
C)40
D)400
E)Indeterminate without the subscription price.

Question 56

Explain the advantages of a shelf-registration to an issuer.How can timeliness of disclosure and a potential market overhang work against a shelf-registration?

Question 57

Discuss what a Dutch auction is and how it works.

Question 58

For a particular stock the old share price is €20, the ex-rights price is €15, and the number of rights needed to buy a new share is 2.Assuming everything else constant, the subscription price is
______ .

A)€ 5
B)€13
C)€17
D)€18
E)€20

Question 59

The Holyoke Corporation has 120,000 shares outstanding with a current market price of €8.10 per
share.The company needs to raise an additional €36,000 to finance new expenditures, and has
decided on a rights issue.The issue will allow current shareholders to purchase one additional
share for 20 rights at a subscription price of €6 per share.
Calculate the ex-rights price that would make a new shareholder indifferent between buying shares
at the old share price and exercising the rights or buying the shares ex-rights.

Question 60

Consider the following two statements: (i) In a firm commitment cash offer, a company negotiates an agreement with a bank to underwrite
And distribute the new shares.
(ii) In a Dutch auction cash offer, a company has underwriters sell as many of a given number of
Shares to be sold at the agreed-upon price.

A)(i) is correct, (ii) is incorrect.
B)(i) is incorrect, (ii) is correct.
C)Both (i) and (ii) are correct.
D)Both (i) and (ii) are incorrect.

Question 61

Lamar Inc.is attempting to raise €5,000,000 in new equity with a rights offering.The subscription price for the 125,000 new shares will be €40 per share.The equity currently sells for €50 per share and there are 250,000 shares outstanding.What will the price per share be if all rights are exercised?

Question 62

RunFast Inc.wants to go public.It decides to do so via a Dutch auction underwriting.It receives the
following bids: The company will offer 600 shares in the IPO.How many shares will the highest bidder get, if allocation is done on the basis of the ratio of shares offer to shares bid at the offer price?

Question 63

RunFast Inc.wants to go public.It decides to do so via a Dutch auction underwriting.It receives the following bids: After the auction it is announced that the company's shares will be offered for EUR 15 per share in the IPO. The company will offer 600 shares in the IPO.How much money will RunFast raise, if allocation is done on the basis of the ratio of shares offer to shares bid at the offer price?

Question 64

RunFast Inc.wants to go public.It decides to do so via a Dutch auction underwriting.It receives the following bids: The company will offer shares in the IPO at EUR 15 per share.At that price, there is no need to allocate a ratio of shares.There is a 15 per cent Green Shoe provision.The underwriters expect that the share will trade at EUR 20 within 30 days after the IPO.They receive a fee of EUR 1,000 for the IPO.How much do they expect to make in total from the IPO?

Question 65

RunFast Inc.wants to go public.It decides to do so via a Dutch auction underwriting.It receives the following bids: After the auction it is announced that the company's shares will be offered for EUR 15 in the IPO. How many shares will be issued by RunFast Inc (assuming there is no need to allocate a ratio of shares)?

Question 66

Lamar Inc.is attempting to raise €5,000,000 in new equity with a rights offering.The subscription price will be €40 per share.The stock currently sells for €50 per share and there are 250,000 shares outstanding.How many rights are needed to buy a new share?