330 Exam2
Underwriter fee
The fee that the underwriter earns will be the initial price paid to the issuer for taking on the corporate bond, minus the price at which the corporate bond is offered to the public.
•Market microstructure
-is the study of the way financial markets are organized and how that organization affects risk, liquidity, market efficiency, market integrity, transaction costs, and any other aspects of markets
Secondary Public Offering
- the sale of shares from existing shareholders - non-dilutive - when existing investors (usually large institutional ones) sell their ownership share to the public so the total # of shares outstanding does not change
Explain why setting the IPO price is challenging
-no market price -could be a new industry -usually a new firm -dont want to be too high (mad investors) or too low (bad rep as an underwriter)
Why go public ?
-More than 499 investors allowed -capitalize on success of one business to pursue another -raise more capital
Terms of offering (domestic/int'l, etc.)
•Terms of IPO are not tailored to the needs of a particular group of investors •Typically, a large # of investors
Market integrity
-refers to market fairness, that is, all participants have equal access to the market and relevant information A. Insider trading (trading ahead of price-sensitive announcements) B. Market manipulation (rumors, etc.) C.Broker-agency conflict (front-running, etc.)
Broker-Agency Conflicts
arise from a broker failing to honor its duty to customers •Front-running-is the illegal practice of a broker trading ahead of a client order to take advantage of the anticipated price impact of the client's trade
Limit order book
-is a record of outstanding limit orders (price and quantities) •These orders cannot be executed immediately b/c there are no counter parties willing to trade at the limit order P •In 2000, the SEC created a centralized LOB that keeps track of limit orders on exchanges electronically •Automatically matches the best pair of orders in the system
Market Spread Example •Dealer 1 quotes $10.00-$10.50, his spread is $0.50 •Dealer 2 quotes $10.25-$10.75, his spread is also $0.50 •What's the market spread?
$10.25 - $10.50
Private Placement
-is a sale of securities to a pre-selected number of individuals and institutions. •Private placements are relatively unregulated compared to sales of securities on the open market. •Private sales are now common for startups as they allow the company to obtain the money they need to grow while delaying or foregoing an IPO
Why do firms care about stock price?
- Financing - usually signals strong company performance and brings lower interest rates - Managerial compensation - tied to stock performance - "Wrath of shareholders" - if management doesnt produce gains - Hostile takeover threat - more costly to buy out - Ego - Positive press - increases demand
Market Efficiency
-refers to the degree to which market prices reflect all available and relevant information A. Transaction costs-all costs (direct and indirect) that are related to trading in securities B. Price discovery-is the overall process of setting the proper price of an asset that depends on market structure, liquidity, and information flow. Essentially, it is finding where supply meets demand.
Regulation D
-the SEC regulation that governs private placement exemptions •Reg D is good for firms & entrepreneurs b/c funding can be obtained faster and cheaper than with a public offering. •The regulation allows capital to be raised through the sale of equity or debt securities without the need to register those securities with the SEC. However, many other state and federal regulatory requirements still apply. •While Reg D makes raising funds easier, investors still enjoy the same legal protections as other investors, since these securities are not exempt from antifraud, civil liability, or other provisions of federal securities laws
Liquidity
-the ease with which an asset, or security, can be converted into cash without affecting its market price •Liquidity is a valuable component of an asset price •Higher(lower) liquidity results in lower(higher) transaction costs •Liquidity measures: spread, price impact, trading volume, order depth
Primary market
-the market for the initial sale of securities •The proceeds from the sale of securities to investors go to the issuers of the securities•Primary market provides businesses with funds to operate and expand •Primary market provides governments with means to carry on their activities•Underwriter facilitated
•Secondary market
-the market for trading already issued assets among investors•Issuers do not get any proceeds from the sale of securities in this market •Traditional secondary markets: NYSE, Nasdaq, OTC markets, etc
Briefly explain three highlights of Reg NMS and their importance. For this assignment you need to access the original Reg NMS document and briefly go over it.
1. Order Protection Rule: allows investors to receive the best price - trading centers take action to prevent trades at prices inferior to protected quotations displayed by other trading centers 2. Access Rule: Non-discriminatory access to prices across trading centers 3. Sub-Penny Rule: Prohibits any orders with increments smaller than a penny, unless the order is below $1 per share
Exchanges
13 in the US Same asset can be traded on mulitple exchanges
Angel Investor
A HNW person who provides financial backing for small startups at their early stage in exchange for ownership stake •focused on helping startups take their first steps, rather than the possible profit they may get from the business. •Example of firms:DoorDash, PayPal, LinkedIn
Price stabilization bid
A stabilizing bid is a purchase of stock by underwriters to stabilize or support the secondary market price of a security immediately following an initial public offering (IPO). After an IPO, the price of the newly issued shares may falter or be shaky in trading.
Lead Up to the Roadshow
After SEC finishes the review with major comments, issuer can set file range(expected offer price) •Usually $2 wide Prints red herring •Also known as preliminary prospectus •Includes a legend in red ink on the cover stating that the registration statement has not yet become effective
Latency
All exchanges are concerned about the speed at which the orders are executed, which is governed by the venue's latency •Latency is any delay or lapse of time between a request and a response •For example, BATS Exchange executes trades in less than 250 microseconds on average! •Co-location is important •Traders co-locate their computers near exchanges so that the information can travel as fast as possible •Some use microwave networks to exchange signal between venues •In 2011, the latency b/w Chicago and NY exchanges dropped from 7.5 to 2.5 millisecond because of the new microwave network
All or None Order (AON)
An order that instructs the firm to execute the entire order. Firm does not have to execute immediately.
Quoted Bid-Ask Spread
Ask - Bid
Ask Price
Ask price-is the price at which the dealer is willing to sell you a stock •So if you want to buy a stock, you will get the ask price
Bid Price
Bid price--is the price at which the dealer is willing to buy a stock from you. •So if you want to sell, you will get the bid price
SPAC
Blank check companies •Special purpose acquisition company (SPAC) is a company with no commercial operations that is formed strictly to raise capital through an IPO for the purpose of acquiring an existing company. •SPACs are formed by investors with expertise in a particular industry or business sector, with the intention of pursuing deals in that area. •They pool money from investors and place it an interest-bearing trust. These funds cannot be disbursed except to complete an acquisition or to return the money to investors if the SPAC is liquidated. •A SPAC generally has 2 years to complete a deal or face liquidation. •After an acquisition, a SPAC is usually listed on one of the major stock exchanges.
•How can firms mitigate the risk of moving prices when making transactions?
Dark pools and...
Timing limit orders
Day Orders - only that same day Good til cancelled - self explanatory immediate or cancel - explanatory
Implicit Cost: Bid-ask spread
Difference between ask and bid price More liquid assets have lower spread BAS is compensation for suppliers of liquidity for: - order processing costs - cost of financing dealer's inventory - inventory holding costs (of market fluctuations)
Types of crowdfunding
Donation Based Rewards Based Equity Based
How to Determine Share Price
Dutch Auction or Book-building
Dealer vs Market Spread
Each dealer has their own quoted spread, called the dealer spread •Thanks to the spreads offered by all the dealers, we get the market spread, which is simply the best ask and the best bid prices selected from all available quotes
Explicit Transaction Costs (direct costs)
Easily observable and quantifiable Itemized separately and investors pay for these just like any other expenses •Example: investment banker or broker fees; costs of acquiring information; taxes; and transfer fees
3 reasons why companies care about their stock price
Ego Low interest rates due to signaling Good press Managerial compensation 1 more
Quantity limit orders
Fill or kill All or none
Follow-on offerings or Seasoned Equity Offerings (SEO)
Follow-on offers (aka SEOs): refers to any issuance of shares that follows a company's IPO. Dilutive Reasons for SEO: •Raise new money to fund operations •Grow the business •Buy new equipment and machinery •Purchase land or buildings •Pay down debt •Make mergers and acquisitions •Recapitalize the business •Increase working capital •Evidence suggests that firms that conduct SEOs are overpriced •Evidence also suggests that offering firms experience poor stock price and earnings performance in the 3 year period subsequent to the offering
In the past, when private companies would reach a certain size and would like to continue to grow, they would file for an IPO and go public. However, there has been a steady decline in the number of IPOs over the last 5-7 years despite the strong economic growth and bull markets (disregard Year 2022). What are some underlying reasons for that phenomenon? What are some of the alternatives that have emerged as a result? Please research this topic using external sources (news articles, research papers, etc.).
Going public via an IPO has become much less common in recent years because it is very expensive and time consuming. Firms have found that these IPOs are generally unsuccessful and have found different avenues to allocate their funds in order to build their firm. Private firms have been able to raise plenty of capital via hedge funds and private equity firms without going through all of the red tape and meeting all of the requirements for a publicly traded company. Some alternatives that have emerged as a result are SPACs, or special purpose acquisition companies, crowdfunding, and private placement. SPACs are publicly traded companies that are formed by experts in an industry solely for the purpose of acquiring a company to take them public 'overnight.' These alternatives are much cheaper for the firm going public but the SPAC process is very under-regulated at the moment, so we will likely be seeing changes to this in the future.
How to lower taxes on stocks?
Hold for more than 1 year Offset gains with capital losses Tax advantage IRA or 401k accounts
Price Impact
How your transaction impacted the price of the security
Raising Capital
IPO Follow on (Seasoned Equity Offering) Secondary Public Offering Raising Debt
Secondary market process
If you want to buy/sell a security, you will do so through a brokerage firm(MerillEdge, Charles Schwab, Fidelity,Vanguard, etc.) •Then, brokers have several avenues (trading systems) by which they can execute a trade
donation-based crowdfunding
Individuals give small amounts to meet the larger funding aim of a specific charitable project while receiving no financial or material return there is no financial return to theinvestors or contributors (disaster relief, charities,nonprofits, and medical bills)
Informed Traders
Interested in collecting information others might not have •A commodities futures trading firm in NYC employs a meteorologist to forecast weather in South America •Brokerage firm employs analysts to study specific firms, industries, regions and countries to forecast stock Ps •Observation of client order flow can provide brokers with valuable information on the state of the market
Discuss two current (<1 year) issues related to dark pools. Please use reputable news sources.
Last week, FINRA announced that they were fining Deutsche Bank to the tune of $2 million dollars for violating Best Execution rules within Dark Pools. According to FINRA, Deutsche routed some of its customer's orders through its dark pool, SuperX, between the years 2014 and 2019. The firm knew that this was going on but did not fix it, harming investors by delaying their orders and having their orders filled at lower amounts. In another recent event, AMC stock has suffered from the wrath of dark pools. Despite the recent release of the new Batman movie, which posted record post-pandemic box office sales, the AMC stock has dropped this past week. Experts on NASDAQ.com have been speculating that the stock price decrease is due to dark pools and naked shorts in efforts to hold the stock back. It is uncertain in the future whether or not the stock price will be able to break through this barrier, as the resistance is strong. However, CEO Adam Aron has recently outlined six key strategies in an effort to revive his company and improve the stock price. The power of dark pool activity is strong and is an area of financial markets that must be regulated in order to maintain a fair free-market economy.
Crowdfunding advantages
Reach - access to 1000s of accredited investors •PR & Marketing - promote through social media and email newsletters •Feedback on how to improve your product •Efficiency-streamlines your fundraising efforts by building a comprehensive profile •Fees - low fees
Benefits of secondary markets
Liquidity Price Discovery
Components of Market Quality
Market Efficiency Market Integrity
Types of Regulations
Merit Regulations Disclosure Regulations
Indirect Cost: Price Impact
Order executions has a potential to move market prices, beyond the bid-ask spread •This effect is called the price (or market) impact •Prices move upward when buying and downward when selling •Relevant mostly to large institutional investors that trade in large quantities
REG NMS
Order protection Access Sub penny
Passive vs active orders
Passive (limit) orders sell at the bid, while active(market) orders buy at the bid
Price impact = ???
Price you originally get - price you would get if you were to buy/sell one additional share after you complete your transaction
What is a limit order book?
collection of limit orders waiting to be executed
Direct Cost: taxes and transfer fees
ST capital gains tax - 1yr or less. The same as your usual tax bracket. •LT capital gains tax - asset held for 1yr+. LT capital gains tax rates are 0%, 15% or 20% •Taxes on dividends: the tax rate on non-qualified dividends (paid by foreign firms, dividends on stock options, etc.) is the same as your regular income tax bracket; while tax rate on qualified dividends is 0%, 15% or 20% depending on your taxable income and filing status
Crowdfunding disadvantages
Scrutiny and rejection - many platforms have very detailed rules as to what's accepted •Competition-CF platforms have 1000s of campaigns •Leakage of valuable info-If your product is not patented, risk of someone stealing your idea •Risk of failure-hard to recover if your campaign fails
Private Offering Regulation
Securities purchased in a crowdfunding transaction generally cannot be resold for one year. •Reg CF offerings are subject to "bad actor" disqualification provisions: •Disqualify offerings if the issuer or other "covered persons"have experienced a disqualifying event, such as being convicted of, or subject to court or administrative sanctions for, securities fraud or other violations of specified laws.
Transaction Costs
The cost of buying and selling an asset (transaction costs) is an important determinant of investment returns •It is easier to reduce costs, say, by reducing portfolio turnover, than to increase the portfolio's returns to pay for higher transaction costs! •Transaction costs are all the costs associated with the management of investments, including the time involved in making investment decisions
Primary Vs Secondary Market
The primary market is where securities are created, while the secondary market is where those securities are traded by investors. In the primary market, companies sell new stocks and bonds to the public for the first time, such as with an initial public offering (IPO).
Private Offering Tiers
Tier 1: Offering size limited to $20 million •No ongoing disclosure •State securities regulations (blue sky laws)-state-level, anti-fraud regulations Tier 2: Offering size up to $50 million •Ongoing disclosure of 10K, 10Q, and 8K •No state securities regulation
Effective Spread
Trade Price - Quote Midpoint If you buy at the ask and then sell at the bid, the entire spread has been incurred as a cost. Since there are 2 transactions, the cost of each is the half-spread
REG NMS: Order Protection Rule
Trade-through Rule •Requires that the best bid and ask prices to be displayed in all markets.•If the best price is a displayed price, it cannot be "traded through", or in other words, it cannot be ignored. •Aims to create a level playing field for all investors by providing equal access to prices and mandating trades be executed at the best price.
Underpricing Securities
Underwriters typically underprice the securities (P increases from the offering price in the short run)... •To encourage investors to reveal their true interest in the firm. As a reward, underwriters will underprice so that investors could make $ after selling the securities •Cheaper prices makes it easier to sell •May make it easier to sell follow-on offerings •May protect the firm from lawsuits •Need to underprice just right: if too underpriced-firm doesn't raise enough $ and bank's reputation is ruined; •if not enough underpriced or overpriced-investors will be disappointed, stock P↓, banks reputation is ruined
Limit order
You set a price, timing, and quantity to trade at There is a chance your order never is executed Collection of these orders make up the limit order book
Dealer Markets
are the markets in which liquidity is supplied by professionals •Dealers, or market makers, electronically display the prices at which they are willing to "make the market," that is, to buy or sell a security. •Dealers make money on the bid-ask spread and incur costs from hiring staff, purchasing equipment, etc. •Examples: bonds and foreign exchanges trade primarily in the dealer markets; while stock trading on the NASDAQ is a prime example of an equity dealer market
Secondry Market
a market for trading securities among owners that does not involve the issuer of the securities •Securities traded: equities, fixed income securities, derivatives, foreign exchange •The specific rules and institutions for trading the above product types are collectively called market architecture
fill or kill order
a trading order which if not filled immediately expires
equity-based crowdfunding
allows contributors to become part-owners of your company by trading capital for equity shares. As equity owners, your contributors receive a financial return on their investment and ultimately receive a share of the profits in the form of a dividend or distribution
Institutional Investors
are entities which pool $ to purchase securities, real estate, and other investment assets or originate loans. Examples: banks, credit unions, insurance companies, pensions, hedge funds, REITs, investment advisors, endowments, and mutual funds.
Private Equity
are groups of investors that use pools of capital from wealthy individuals, pension funds, insurance companies, endowments, etc. to invest in businesses (buying ownership interest). PE make money from: •a) convincing capital holders to give them large pools of money and charging a % on these pools and •b) generating returns on their investments. They are investors, not advisors.
Individual (retail) investors
are non-professional investors who invest much smaller amounts •In contrast to institutional investors, individual investors have smaller influence and impact on the market and the companies they invest in; they do not have the advantage of professional research, traders, and portfolio managers
Crowdfunding SEC Regulation
enables eligible companies to offer and sell securities through crowdfunding •Applies only to equity-based crowdfunding! •All transactions must take place online through an SEC-registered intermediary (broker-dealer or a funding portal) •Permit a company to raise a maximum of $1,070,000through crowdfunding offerings in a 12-month period •Limit the amount individual investors can invest across all crowdfunding offerings in a 12-month period and •Require disclosure of information in filings with the SEC and to investors and the intermediary facilitating the offer in
Market Order
executed immediately Market buy is at the lowest ask price Market sell is at the highest bid price
Direct Cost: Commissions
fees charges by brokers/dealers for facilitating the trade •Vary significantly depending on financial instrument and the brokerage firm •Commissions on options, futures, and ETFs are usually higher •Competition and tech advances drove fees down to zero* (*-limitations include # of trades, type of assets (OTC vs exchange traded; domestic vs int'l, etc.) •For large customers, commissions are negotiable
Disclosure Regulations
focus on ensuring that market participants fully disclose information so that investors can make informed decisions •In the US, the SEC does not decide how much investors should pay for shares •Instead, they require corporations to disclose information that allow investor to make informed decisions
IPO (Initial Public Offering)
initial sale of stock to the public (private company goes public for the first time)
rewards based crowdfunding
investor receives a "reward," typically a form of the product or service the campaign offers. Closely related to donation-based as there is no financial or equity return
Crowdfunding
is a method of raising capital through the collective effort of friends, family, customers, and individual investors. •Taps into the collective efforts of a large pool of individuals—primarily online via social media and crowdfunding platforms—and leverages their networks for greater reach and exposure. •Crowdfunding platforms: Kickstarter, Indiegogo, Patreon, Crowdrise •Investor-focused CF portals: Wefunder and Startengine
Market Manipulation
is an intentional act of creating an artificial price for a security defrauding the investors. Some examples: •Runs-create rumors to drive prices up or down •Guinness stock scandal in the 1980s •Twitter bots •Quote stuffing - HFTs overwhelm exchanges with numerous quotes to gain advantage over slow traders
SEC Regulation A+
is intended (a) to make access to capital possible for small and medium-sized companies that could not otherwise bear the costs of a normal SEC registration and (b) to allow non accredited investors to participate in the offering.
Implicit transaction costs (indirect costs)
not easy to observe and quantify •the difference b/w the price at the time the decision to buy/sell is made and the price actually paid (called price impactor market impact); •the bid-ask spread; •market timing costs(when the stock price moves in response to factors unrelated to the particular transaction); •opportunity cost(loss in profits from trades that are missed or not executed) •Can be more than 3x the size of explicit costs
Venture Capitalist
private equity investor that provides capital to companies exhibiting high growth potential in exchange for an equity stake •Do not usually fund startups from the onset •Rather, they seek to target firms that are at the stage where they are looking to commercialize their idea. •In exchange for the high risk that VCs assume, VCs usually get significant control over company decisions and ownership. •VCs often provide strategic advice and marketing strategies •Example of firms: Facebook, Groupon, Google, Twitter, Spotify, Dropbox
Limit buy
purchase at or below a price P
Merit Regulations
require certain actions deemed to be in the public interest or prohibit certain actions that are deemed contrary to the public interest •Certain financial products may be banned; the makeup of the board of directors may be specified; specific securities may be reviewed and rejected for sale b/c they are too risky. •SEC has prohibited stock exchanges from enforcing fixed commissions (each brokerage firm is free to set its own commissions and commissions are negotiable)
REG NMS: Access Rule
requires fair and non-discriminatory access to quotations, establishes a limit on access fees, and requires the exchanges to establish, maintain and enforce rules •The goal is to create an environment in which there is fair and efficient access to quotes throughout the National Market System (NMS)
Limit sell
sell at or above a price P
Employee Retirement Income Security Act (ERISA)
stimulated interest in monitoring and assessing the cost of asset management. •ERISA requires that "plan assets must be used for the exclusive benefit of the plan and its participants, and fiduciaries' actions must be consistent with professional money management practices." •Interest in measuring and assessing transaction costs has quickly spread to other managers as well!
Direct Cost: Information Cost
the costs associated with obtaining information necessary to trade. •time, effort, and energy to learn how to use the online trading tool offered byE*Trade •Costs of learning about the fin instrument you wish to trade(financial reports, analyst recommendations) •Banks, pensions funds, and mutual funds make significant investments to forecast economic and industry conditions and predict which assets would perform best in those conditions •Some products (like commodities) require an advice of a lawyer, accountant, financial advisor
Bid-Ask Spread
the difference between the bid price and the asked price this is the profit that the dealer makes on securities lowest big and highest ask across all exchanges is the NBBO (National Best Bid and Offer) Reg NMS ensures that when you submit your limit order it is executed at the NBBO
Price Discovery
the identification of the equilibrium price of an asset through the process of trading •Helps firms determine the market's valuation of the firm's investments •The process looks at a # of factors like the arrival of new information on the market or forces of supply and demand, etc. that help determine a fair price for an asset •Not the same as valuation or intrinsic value!
Insider Trading
traders that have non-public, material information about the stock for any reason •An individual who has access to insider information would have an unfair edge over other investors, who do not have the same access, and could potentially make larger, unfair profits than their fellow investors. •For example: A company lawyer has confidential info about the firm and uses it to buy/sell stocks or even shares this information with her relatives •However, someone who overheard a conversation at a nearby table at lunch would not normally be barred from trading on that info
Stop loss order
you specify a price for your order to execute at sell stop order is below the current market price and is used to limit loss / protect profit buy stop order is above the current market price and is used to limit a loss / protect profit on a stock that has been shorted
Issuing firm selects investment bankers(underwriters)
•"Beauty contest," pitch books, track record, reputation •If a bank invests its own $ in addition to raising capital from the public, it is called a merchant bank
How Private Firms Raise Capital
•Angel investors •Venture capitalists •Private equity firms •Institutional investors •Individual (retail) investors Alternative methods: •Private placement •Crowdfunding •SPACs (results in the firm going public)
SPAC Advantages
•Cheaper and faster way to raise $, comparing to an IPO •The target company can negotiate its own fixed valuation with the SPAC sponsors
Consequences of NMS
•Critics argue that by mandating that orders be routed immediately to the trading venue with the lowest price, despite the cost, there has been a proliferation of trading venues •Referred to as market fragmentation •In order to attract order flow, exchanges and ATSs have incentive programs and innovative order types •All of this makes trading environment complex and difficult to regulate
Alternative Trading System: Dark Pools
•Dark pools--Private exchanges run by either major brokers, exchanges, or private firms •Named so for their complete lack of transparency •Trade execution details are released with a delay •Used by large institutional investors wishing to conceal their trading intentions •Prices seen by investors on exchanges may not reflect real market prices •Easy prey for predatory HFTs, since pool owners secretly sell them access to their dark pool •Pool participant may not get the best price
PRIMARY MARKETS
•Difference b/w primary and secondary markets •IPO Process (steps, why this is such a lengthy process, role of an underwriter in helping firm go public, auction styles, aftermarket etc.) •Why are IPOs not as popular anymore? •Other ways for the firm to raise money in the primary market (debt etc) •Alternative ways of raising capital (angel investors, etc.) and corresponding regulations (A, D, and CF)
Debt vs Equity raising historically
•Evidence suggests that companies issue more debt, more debt relative to investment spending, and more debt compared to equity when interest rates are low relative to historical rates
Secondary market trading systems
•Exchanges-organizations whose members or participants trade securities among themselves at a fixed location(computer or trading floor) •Dealers-OTC market where 35k+ securities are traded by dealers who quote prices at which they buy/sell •Alternative Trading Systems-bring buyers and sellers together electronically via crossing networks (include ECN and dark pools)
•Decide on type of underwriting
•Firm commitment •Best efforts •All or none
Syndication
•Formation of the group of underwriters along with the lead underwriter(usually when the issue is too large for one firm to handle) that will purchase the securities from the issuer and sell to investors in the future
Costs of going public
•High offering expenses •Legal and accounting fees for preparing the registration statement •Underwriting fees (gross spread) for placing the issue and making a market in the securities •Takes a lot of management time that could be used for building the company •Includes post-IPO compliance with securities laws •New investor base may shorten horizon of firm's decision-making •Have to tell the world (and your competitors) all about your business
Aftermarket demand is high
•If demand is high and the price goes up, the underwriter will cover its short with shares from exercising the Greenshoe (or over allotment) option (Limited to 15% of the offering)
Aftermarket demand is low
•If demand is low and the price goes down, the underwriter will cover its short with shares purchased in the market •Price stabilization bids (have to be flagged so that they are transparent and must be at the offer price or less)
Alternative Trading System: ECN
•In 1998, the SEC authorized the creation of ECNs •BaxterFX; Hotspot FX;Fastmatch; Track ECN; Brut ECN; Chi-X ECN •ECNs operate like exchanges, often having a limit order book, but deal with institutional clients •Provide anonymity and are fast
Trade Reporting
•In the US, exchanges report trades to the Consolidated Trade System and quotes to the Consolidated Quotation System •Both part of the Consolidated Tape System. •Non-exchanges (like ECNs and dark pools) report their trades toTrade Reporting Facility immediately
Process of going public
•Issuing firm selects IBs (underwriters) •Due diligence (write prospectus) •Syndication •Terms of offering (domestic/int'l, etc.) •Decide on type of underwriting •Setting price •Trading
Dutch Auction
•Less common but way better •Underwriter accepts a series of bids from investors that include number of shares and price per share •The market-clearing price is the highest price that will result in all shares being sold
Private Market Advantages
•Less disclosure •May be a faster way to obtain $ (but smaller amounts) •CEOs of public firms are too focused on quarterly earnings and not enough on LT value creation, unlike managers of private firms
TRANSACTIONS AND REGULATIONS
•Limit order book and its specifics (NBBO, spreads (quoted, effective, dealer, market), bid and ask sides, types of orders and where your order goes to in the limit order book when you submit it, how theLOB changes after a trade •Corresponding regulations •Components of market quality
Private Market Disadvantages
•Little to no liquidity •You commit your investment for many years •Private investment is more labor intensive •Restrictions on type of investor that can participate
SPAC disadvantages
•Loosely regulated going-public process•allows startups to attract investors with bullish financial projections, despite having little or no revenue in their history •Lots of speculation going on: empirical research found a correlation between ambitious forecasts and poor stock performance •Regulations are coming!
Purpose of Roadshow
•Management meetings with investors •Must only discuss information available in the red herring •Underwriters gather interest in the offering after the roadshow •Uses information to adjust offer price
Disclosure Regulation Example: Regulation Fair Disclosure (RegFD) of 2003 (!)
•Mandates that companies release info to the public and investment professionals at the same time• The goal was to level the playing field for all investors and prevent loss of confidence in the markets
Setting IPO price is challenging:
•No existing market price •Firms often have short operating history •Forecasting is difficult (limited info, sometimes new industries
Once the SEC declares the offer effective, underwriters...
•Set final offer price •Begin confirming indications of interest from investors •Allocate shares •Prepare for trading
SECONDARY MARKETS
•Specifics of secondary markets (benefits and challenges) •Trading systems (exchanges, etc.)
The first regulation concerning stock exchanges were passed as the result of the stock market crash of 1929
•The Securities Act of 1933 •The Securities Exchange Act of 1934 •Both encouraged self-regulation, but within a statutory framework
Limitations of SEC Regulation D (Reg D):
•The benefits of Reg D are only available to the issuer of the securities, not to affiliates of the issuer or to any other individual who might later resell them. •What is more, the regulatory exemptions offered under RegD only apply to the transactions, not to the securities themselves.
Private Placement Steps
•The firm offers an issue to investors that have 3weeks to decide •Once investors commit, negotiations begin, and due diligence is performed by investors •Investors then determine credit rating of the firm and decide on the price that would compensate for this risk •Investors then invest
Raising Debt
•The issuance of bonds essentially creates a loan between a group of investors and the corporation. •The issuing process is very similar to the IPO and SEO process •The issuer hires an underwriter(s) that helps with the filing process, buys the bonds from the issuer and sells them to interested investors (often large institutional investors that are polled to determine the appropriate coupon and maturities)
Aftermarket lockup provision
•The lockup provision becomes effective •Large investors and employees cannot sell the stock in the aftermarket for 180 days to prevent depressing the stock P •If the trading in the aftermarket goes well, the underwriters sometimes remove this restriction
SEC Filing
•The next step is to file the registration statement with the SEC •Includes information on •Financials •Use of proceeds •Business and strategy •Risk factors •...but no pricing information •SEC reviews the document and can either accept it or send it back for additional work
Aftermarket Quiet Period
•The quiet period begins and lasts until 40 days after the stock starts trading. •During this time, the company must not issue any new info that is not already contained in the registration statement •Its purpose is to create a level playing field for all investors by ensuring that everyone has access to the same information at the same time.
Best Efforts
•Underwriter agrees to use only their best efforts to sell the issuer's securities. No commitment to purchase any unsold securities •Banker offers the issue continuously until the issue is successful or terminated •Typical for smaller or less reputable banks
Firm Commitment
•Underwriter guarantees the sale of all shares by purchasing the security for resale to the public •Investment bank risks more, the issuer risks less •Buy at one price, resell at higher price (∆ in$ is called underwriting spread) •In US, the sale price is stated in the offering documents and is firm; but inSingapore, Portugal, and Japan price discrimination is allowed (employees and domestic investors, for example)
Due Diligence
•Underwriters and lawyers inspect financial statements, research industry/market/future potential, draft registration statement. Customers, legal and industry experts, accountants are involved •Registration statement is filed with the SEC •A shorter version, prospectus, is distributed among investors (describes the offering and finances)
All-or-none
•Unless the entire issue is sold at the offering price, the deal is voided, and the underwriter will not receive any compensation
Regulation NMS
•Used to be that trading occurred only where companies are listed •NYSE-listed company could only be traded on NYSE •But it is not the case anymore •Who determines where the trade will take place then when you place an order to buy/sell a security? •The answer can be found inRegulation NMS that was adopted in 2005 by the SEC •The goal is to improve market efficiency and fairness
Book-building
•more common •Lead underwriter determines a price range through frequent contact with investors and their own valuations •During the "road shows" process orders for shares are taken (Quant&Price) •Based on these orders, the price is determined •Popular, but very biased methods (as underwriters have an incentive to maximize the underwriting fees they collect)