FP513: Module One

Investment Banks

Financial institutions that assist corporations and municipal governments in raising capital by underwriting new securities or acting as issuer’s agent in issuance of new securities.

Initial Public Offering (IPO) Investment Bank Functions

• Advising corporation

• Buying securities from issuer to resell to public

Firm Commitment

Investment banker purchases any shares that remain unsold.

Best Efforts

Underwriter will make every effort to sell all shares, but company going public receives nothing for unsold shares.

Dilution

Effect of companies doing secondary or seasoned offerings. Lowers value of each share and earnings per share.

Red Herring

Preliminary prospectus

Prospectus

Offering document for sale of securities

Registration

Filing of prospectus with SEC

Green Shoes

Right to increase size of offering

Syndicate

Investment banking companies that participate with managing underwriter to assist in distributing shares.

Selling Group

Firms that help distribute but are not part of syndicate.

Lock-Up Period

180 day period when investors cannot resell their shares.

Broker

Agents of sellers of securities who receive a commission for executing trade.

Dealer

Principal who buys and sells securities for own accounts.

Bid

Price dealer is willing to pay to buy.

Ask

Price dealer is asking to sell at.

Venture Capital

Financing for privately held companies. High risk, high return.

Seed Capital

For new companies that provides money for research and development.

Start-Up Capital

Cash provided for initial marketing, NOT production or sales.

First-Stage Financing

Cash is provided for manufacturing and sales.

Second-Stage Financing

Cash is provided for working capital

Mezzanine Financing

Cash is provided for expansion and new products.

Bridge Financing

Capital is provided fro an expected IPO.

Acquisition Financing

Capital is provided to acquire other companies.

Leveraged Buyout (LBO) Financing

Capital is provided to allow management to buy all or part of a business.

Private Placements

Process through which company shares an issue, usually bonds, to a small group of institutions or sophisticated individual investors. Limited to 35 unaccredited, but unlimited accredited investors. Avoid SEC registration and selling costs are eliminated.

Limited Partnerships

A partnership consisting of a general partner and limited partners.

Primary Market

Facilitates initial sale of securities issued to the public. Funds flow from investors to issuing company.

Secondary Market

Provides investors with a method of buying and selling previously issued securities.

Made up of:

• First Market: Exchange (auction) market

  • Listed securities trade

• Second Market: Unlisted securities

• Third Market: Over-the-counter trading of exchange-listed securities

• Fourth market: Institutional investing of large volumes between themselves

Public Float

Indicates number of shares that are available for trading by investors

Types of Orders

• Market Order

• Limit Order

• Day Order

• Good-til-Cancelled (GTC) Order

• Stop Order

• Stop-Limit Order

Certificate Form Ownership of Common Stock

Investor is issued a certificate of ownership by corporation.

Street Name Ownership of Common Stock

Investors use a brokerage firm to hold stock in brokerage account on their behalf.

Securities Investor Protections Corporation (SIPC)

If brokerage firm liquidates, SIPC insurance investor’s accounts up to max value of $500,000 (250k for cash balances).

Short Seller

Bearish about market, benefits if price of stock goes down.

Borrows stock, sells the stock, buys stock back once price decreases, then returns the stock to lender.

Leveraging

Use of borrowed money to achieve an individual’s investment objectives.

Investments Purchased on Margin

50% of funds are deposited by the investor and the 50% may be borrowed from the broker-dealer. This 50% is the initial margin percentage. Once margin account established, must maintain minimum maintenance margin, usually 35%, but depends on BD. If fall below maintenance minimum, investor receives a margin call. If investor does not add cash, a portion of investor’s position will be sold to cover margin call. Debit balance is amount owed to the BD.

Margin Call Formula

margin call = debit balance / (1 - maintenance margin)

margin call = ( (1 - initial margin percentage) / (1 - maintenance margin) ) x purchase price of stock

Holding Period Return (HPR) w/ Margin

HPR = (ending value - beginning value +- cash flow) / initial investment

Cash

Refers to cash equivalents and bank instruments of deposit that have a high level of liquidity.

Liquidity

Ability to sell or redeem an investment quickly and at a known price without a significant loss of principal.

Marketability

The ability to sell an investment quickly and in a readily identifiable market.

Cash & Cash Equivalents

Must be BOTH liquid and marketable.

Certificates of Deposits (CDs)

AKA time deposits, deposits made with a bank or savings and loan for a specified period, commonly one month to 5 years. Interest subject to ordinary income in year earned.

Liquidating CD before Maturity Date

Must pay a penalty in form of either a one-time fee or lower overall interest rate.

Negotiable CDs

Deposits of $100,000 or more placed with commercial banks at a specified interest rate for a term of up to one year. Bought and sold in the secondary market.

Money Market Deposit Accounts (MMDAs)

Bank obligations and are federally insured.

Money Market Mutual Funds

Open-end mutual funds invested in high-quality, short-term investments.

• Taxable Money Market Funds

• Tax-Exempt Money Market Funds - National

• Tax-Exempt Money Market Funds- State

US Treasury Bills (T-Bills)

Short-term government securities issued weekly in maturities of 4, 13, 25, or 52 weeks. Sold at discount and mature at par.

Commercial Paper

Negotiable, short-term, unsecured promissory note issued by a large corporation to finance accounts receivable and inventories. Issued in denominations of 100k or more. Term to maturity is no more than 270 days.

Repurchase Agreements

AKA repos, dealer sells securities to another dealer with agreement to buy them back at later date at agreed price. Rate of interest is repo rate.

Reverse Repurchase Agreement

Dealer buys securities from another dealer and then sells them back later at higher price.

Banker’s Acceptances

Short-term drafts drawn by a private company on a major bank used to finance imports and exports. Trade at discount to face value in secondary market.

Eurodollars

US dollar-Denominated Deposits at banks outside US used to settle international transactions. Maturity is less than 6 months.

Eurodollar CD

Like normal CD, but obligation is a liability of a non-US bank.

Interest Income

Includes income from deposit accounts. All interest income is taxable as ordinary income on both federal and state tax returns.

Income from US government obligations is NOT state taxed.

Income from state and local muni bonds is NOT taxable on fed level and only state taxed if for bond outside state of residence.

Dividends

Includes income from stock. Dividend income is taxable on fed and state level.

Taxed at rates of 0%, 15%, or 20%.

Corporations have exclusion ratio. Some dividends not taxed because treated as return of principal.

Capital Gains Taxation

Same rates as for dividends.

Long term gain: asset held more than one year before sale.

Must net gains and losses for year. Short term gains against losses and long term gains against losses.

Net capital losses are deductible against earned income up to 3k per year. Capital losses not deducted in taxable year may be carried forward indefinitely.

Net Investment Income

Investment income reduced by certain deductible expenses.

Tax is 3.8% of lesser of net investment income or excess of modified AGI over a specified threshold amount.

Wash Sales

Occur if taxpayer sells or exchanges stock for a loss and, within 30 days before or after the date of the sale, acquires similar securities. If event occurs, basis of new tock will include unrecovered portion of basis of formerly held stock.