Chapter 3 pt.1

Primary Market Overview

• The primary market is where companies publish their data and offer shares for the first time.

• Advantages include:

  • Limited public data means competitors have less insight into a company’s performance.

  • Companies can find private placements and investors interested in their shares.

Role of Investment Banks

• Publicly traded firms share information with institutional investors to gauge interest and opinions.

• Roadshows are conducted:

  • Purpose: to gather insights from potential investors about demand and appropriate share pricing.

  • Underwriters (investment banks) collect data on investor interest and share price expectations.

• Truthfulness in pricing:

  • Investors are encouraged to provide honest feedback on share pricing for the long-term benefit of market performance.

Share Pricing and Discounts

• Shares are often sold to investment banks at a discount:

  • Example: Company sells shares worth $30 each to the bank for $25.

  • The $5 difference compensates the bank for its risk and work.

• If shares remain unsold, the bank incurs financial responsibility.

Initial Public Offerings (IPOs)

• IPO pricing example:

  • If the IPO price is set at $30 and trades at $33 by end of the first day, this represents a 10% increase.

• Underpricing is a significant cost to the issuing firm:

  • The firm receives less than the market price on the first day of trading.

  • For example, instead of $33, the firm collects only $25, representing a loss due to underpricing.

Transparency and Investor Behavior

• Transparency of interested investors varies:

  • Investment banks must navigate how candid investors are about their intentions.

  • Roadshows aim to clarify investor interest levels.

• Discussion of various countries and their IPO environments:

  • Countries have different average first-day returns; charts may vary in clarity.

Long-term Performance of IPOs

• Historical data on IPO performance, such as those studied by Professor Jay Ritter, indicates varying outcomes over extended periods.

• Example from personal experience:

  • Investor sold shares of Coinbase at a 10% loss, avoiding a potential 70% loss by holding.

• Direct sales option for companies:

  • Less costly than traditional IPOs, allowing firms to decide based on financial implications.

  • Direct sales do not impose the same restrictions on selling shares that IPOs may enforce.

Summary of Investment Bank Benefits and Costs

• Investment banks help navigate regulatory environments and investor behaviors.

• Costs associated with IPOs include:

  • Fees to investment banks

  • Risks of underpricing

• The critical role of investment banks in structuring and advising throughout the IPO process.