Deck 3: Equity Financing

Question 1

What is private equity? Explain the three types of private equity.

Answer 1

Private equity is any type of share ownership that is not listed on a public exchange,and cannot therefore be traded in the public equity markets.It is an acceptable alternative asset class for financial institutions that wish to diversify their investments away from the traditional debt and equity markets.Private equity investors can earn a return on their investment in three main ways.First,the invested firm may be taken to the markets through an IPO,and the private equity can be re-registered and sold on to the public.Second,the invested firm may be acquired or merged with another company,and the private equity investor will sell its stake on to the acquirer.Third,the private equity investor may sell its shares privately to another private equity investor.Venture capital focuses on the very early stages of a firm's development,and provides funding to start-ups and new firms with excellent potential for growth.Mezzanine financing provides funds for firms that have shown strong potential,but need funding to allow them to be ready for listing in the capital markets.Finally,private equity investors can buy out companies that have potential for future growth and restructure their assets or operations,or act as strategic investors in emerging-market companies.

Question 2

Explain the different types of secondary market for equity.

Answer 2

Secondary equity markets can be organized either as an exchange or as an over-the-counter market.An exchange is a physical location where buyers and sellers come together to buy and sell securities.NYSE Euronext and the London and Tokyo stock exchanges are good examples of organized secondary markets for equities.An over-the-counter (OTC)market,in contrast,allows buyers and sellers to transact without meeting at one physical place.Two alternatives to the traditional exchange-based and OTC-based markets,known as the third market and the fourth market,include elements of both OTC and exchange markets.The third market is composed of exchange-listed equities that can be bought and sold over the counter by a broker.The fourth market consists of large investors who trade exchange-listed equities among themselves,bypassing the exchange.Generally,the trades take place through an electronic communication network (ECN).

Question 3

Which of the following is an advantage for a firm going public?

A)Public firms have government aid during financial turmoil.
B)It is cheaper for public companies to comply with regulations.
C)The shareholders gain better liquidity.
D)Business information is more secure.

Answer 3

C

Question 4

Which of the following is true of public firms?

A)The cost of issuing public equity is always lower than the cost of issuing private equity.
B)Any data provided by public firms to its shareholders is also available to competitors.
C)The investors can influence the daily activities of the business.
D)Investors can demand higher reward for the higher risk associated with the public firms,adjusted periodically.

Question 5

A(n)_____ is a financial instrument that gives its holders a claim on a firm's earnings,paid in the form of dividends,that must be paid before dividends on its ordinary shares can be paid.

A)collateral trust bond
B)bond indenture
C)debenture
D)preference share

Question 6

Which of the following is a disadvantage of private equity investment?

A)Its return on investment will be lower compared to equity investments.
B)The investors gain control of all operational units such as product development,marketing and sales.
C)The investment is long term and illiquid.
D)The investment must be retired after a specific period of time.

Question 7

Which of the following is true of equity and debt?

A)Equity has a secondary market,whereas debt does not have a secondary marker.
B)Equity holders cannot elect the board of directors of a corporation,whereas debt holders can elect the board of directors.
C)Equity holders' claims must be paid in full before the claims of debt holders can be paid.
D)Equity holders receive cash in the form of dividends,whereas debt holders receive interest payments.

Question 8

Priority shares:

A)give the holders certain rights,such as being able to appoint a representative to the board of directors,or veto a proposal at an annual general meeting.
B)restrict voting power of an investor to a specified percentage of shares,irrespective of the actual shareholding.
C)issued by former state-owned enterprises,give the government beneficial powers,such as veto capability against new shareholders.
D)are securities that have an equity ownership stake without voting rights.

Question 9

Which of the following is true of the efficient markets hypothesis?

A)The efficient markets hypothesis summarizes the idea of efficient markets as markets in which prices fully reflect available information.
B)The efficient markets hypothesis summarizes the idea of efficient markets as markets in which both systematic and unsystematic risk can be completely eliminated.
C)The efficient markets hypothesis only applies to large multinational corporations which have both systematic and unsystematic risk.
D)The efficient markets hypothesis states that the expected return of a financial asset is a linear function of various macro-economic factors.

Question 10

Ordinary shares are:

A)investments in which the investors are entitled to receive consistent cash flows.
B)instruments that give holders a claim on a firm's earnings to be paid before paying the bondholders.
C)shares of ownership in a corporation,that are usually entitled to the right to vote.
D)shares of ownership in a corporation,that pay no dividends.

Question 11

Mezzanine financing:

A)provides funds for firms that have shown strong potential,but need funding to allow them to be ready for listing in the capital markets.
B)is for the very early stages of a firm's development,and provides funding to start-ups and new firms with excellent potential for growth.
C)provides capital to initiate commercial manufacturing,advertising and sales.
D)provides capital for firms to go public.

Question 12

What are preference shares? Why do firms choose to issue preference shares instead of straight debt or equity?

Question 13

Which of the following is true of underpricing?

A)Underpricing occurs when the offer price is above the first closing price.
B)Underpricing occurs when the average daily return of the IPO is lower than the market return.
C)Underpricing is measured as the average initial returns measured over the first trading day.
D)Underpricing is measured as the percentage increase from the intrinsic value to the first closing price.

Question 14

What are the benefits for a firm to go public?

Question 15

Which of the following is a disadvantage for a firm going public?

A)Less liquidity for shareholders
B)Costs of dealing with shareholders
C)Less credibility with customers
D)Less transparency of corporate information

Question 16

Material information is information that:

A)if omitted in the valuation,would significantly alter the value of the firm.
B)details only assets and liabilities of a corporate information disclosed due to regulations.
C)the promoters are legally responsible for disclosing as part of the red-herring prospectus.
D)the underwriters disclose while marketing the firm?s initial public offering.

Question 17

If the managers of a firm,which issues IPO,have better information than investors:

A)the investors who are allocated shares in the IPO could be subject to the winner's curse.
B)it is likely that the initial offering will be underpriced to make investors feel better about the secondary issue.
C)the investors will have an incentive to distort their true opinions of an initial public offering to ensure that subsequent issues are accurately priced.
D)then the offer price will be on par with the expected closing price on the first trading day.

Question 18

Which of the following is true of the book-building process?

A)Investors are generally allocated shares in oversubscribed offerings using some fixed formula.
B)Investment banks generally have little leeway in how to allocate the shares of new issues.
C)Investors are allocated shares on a pro-rata basis using the application amount received.
D)The issue is priced more accurately based on the demand for the issue.

Question 19

Which of the following is a reason for issuing preference shares?

A)Unlike bonds,the issuing firm is not obliged to pay any fixed amount.
B)It is cheaper to issue preference shares than to issue ordinary shares or bonds.
C)It improves operating income of the issuing firm.
D)It reduces the financial leverage of the firm.