CHAPTER 10

CHAPTER 10 ASSIGNMENT NOTES

1.​ PRIVATE EQUITY

Two different markets companies in need of funding can turn to:
●​ Private equity market
○​ The business owners cannot sell shares of their company to the public,
●​ Public equity market
○​ The business owners sell shares of their company to the public in
exchange for a percentage ownership of the company.
Venture capital fund
●​ a type of private equity financing that typically invests money in businesses in
exchange for a minority ownership in the company.
●​ Will typically exit from its original investment within four to seven years
Private equity fund
●​ type of private equity financing that typically invests money in businesses in
exchange for a majority ownership in the company.
●​ Because they typically seek large stakes in the company (or sometimes even
100% ownership), private equity funds usually invest more money in a company
than a venture capital fund would.
Crowdfunding
●​ Type of private equity financing that typically invests money in businesses in
exchange for either equity in the business or a tangible reward,

2.​ THE PUBLIC EQUITY MARKET

TYPES OF STOCKS AN INVESTOR CAN PURCHASE TO INVEST IN A PUBLIC

COMPANY

Common Stock
●​ Gives investors ownership and a claim on a portion of the profit (dividends)
●​ The right to vote on key matters of the firm
Preferred Stock
●​ Gives investors ownership and a claim on a portion of the profit (dividends)
○​ Fixed dividend that paid out perpetually
●​ Receive fewer voting rights
●​ Have provisions that give them right to first dividend
3.​ INSTITUTIONAL USE OF STOCK MARKET

4.​ IPO PROCESSES

●​ Decision to Issue IPO: A firm decides to raise capital by going public.
●​ Hiring an Underwriter: A securities firm is hired as an underwriter to manage
the IPO process.
●​ Developing the Prospectus: The firm, with the underwriter, prepares a
prospectus detailing its operations, finances, and risks, which is filed with the
SEC.
●​ SEC Review: The SEC evaluates the prospectus for sufficient information and
requests adjustments if needed.
●​ SEC Approval: The prospectus is approved once deemed adequate and
non-misleading.
●​ Bookbuilding: The firm and underwriter use bookbuilding to gauge demand and
estimate the IPO stock valuation.
●​ Roadshow: The firm conducts presentations to potential investors, promoting the
IPO.
●​ IPO Launch: The IPO goes public, allowing investors to purchase stock.
5.​ IPO STOCK VALUATION
●​ IPO minimum offer price = allocation then choose the lowest price
○​ The shares will then be sold to the highest bidder at each amount, until
the minimum offer price is reached.
●​ Funds Earned
○​ ∑i=(Quantity×Price)
●​ Transaction Cost
○​ Funds earned x transaction cost (%)

6.​ IPO PRICE STABILIZATION

●​ Flipping: Investors buy IPO shares for quick resale at higher prices.
○​ Prevention: Underwriters incentivize holding shares longer; use lockout
clauses.
●​ Lockout Clause: Restricts original owners from selling shares immediately
post-IPO.
●​ Over Allotment Clause: Allows selling extra shares (up to 30%) within 30 days
post-IPO to raise more funds while avoiding a price drop.

7.​ IPO MARKET ABUSES

●​ Spinning: Underwriter offers IPO shares in exchange for future favors.
●​ Laddering: Underwriter encourages above-offer-price bids for future IPO share
reservations.
●​ Excessive Commission: Brokers charge high fees for highly demanded IPO
shares, offset by future returns.
●​ Financial Statement Distortion: Overpriced IPOs due to weak internal controls
and misleading financials; regulated by the SEC.

8.​ STOCK OFFERINGS AND REPURCHASES

●​ Shelf Registration: Pre-approved SEC financials for quick stock issuance within
two years.
●​ Secondary Stock Offering: Public company issues new shares to raise funds
for growth or expansion.
●​ IPO: First-time stock offering for public firms, typically for growth or expansion.
●​ Stock Repurchase: Firm buys back undervalued shares, signaling value and
driving up demand.

9.​ ORGANIZED STOCK EXCHANGES AND OVER-THE-COUNTER MARKETS

●​ Organized Stock Exchanges
○​ NYSE, Nasdaq
○​ High financial standards, SEC registration, trading floors
●​ Over-the-Counter (OTC) Markets
○​ OTCQB, OTCQX, Pink
○​ Lower/no financial standards, no SEC registration, trades via telecom
networks.
 ●​ Wilshire 5000: Price-weighted; ~3,500 U.S. firms
●​ Dow Jones (DJIA): Price-weighted; 30 large U.S. firms
●​ S&P 500: Value-weighted; 500 largest U.S. firms
●​ Composite Index: Price average of all NYSE-traded stocks.

10.​CORPORATE GOVERNANCE AND CONTROL

●​ Shareholder Actions:
❖​ Hold shares and wait.
❖​ Sell shares if dissatisfied.
❖​ Advocate with other shareholders for change.
❖​ Engage in proxy contests to replace board members.
❖​ Sue the board for neglecting shareholder interests.
●​ Poison Pill Provision:
●​ Anti-takeover strategy.
●​ More expensive and difficult for an acquiring firm to purchase a target firm.
●​ Allows existing shareholders to buy more shares
11.​FOREIGN STOCK INVESTMENT
●​ Direct Purchase: Buy foreign firm shares directly if traded on a U.S. exchange.
●​ ADR (American Depository Receipt): Indirect ownership of foreign firms not
traded on U.S. exchanges; broker purchases foreign shares and creates tradable
receipts.
●​ International Mutual Fund: Investing in multiple international stocks or within a
specific country.
●​ ETF (Exchange-Traded Fund): Tracks performance of specific foreign stock
markets
 CHAPTER 11 ASSIGNMENT NOTES

1.​ PRICE -EARNINGS METHOD

●​ Valuation per share=Expected earnings per share×Mean industry PE ratio
●​ Limitations
○​ Incorrect Earnings Estimates
○​ Misleading Accounting
○​ Unrepresentative Industry PE Ratio
○​ Unexpected Stock Buyback
○​ Incorrect RRR
2.​ DIVIDEND DISCOUNT METHOD
●​ Dividend discount = Dividend / (rrr -g)
●​ Limitations
○​ Incorrect Dividend Estimates
○​ Incorrect RRR
○​ Incorrect Dividend Growth Rate
○​ High RE
3.​ ADJUSTED DIVIDEND MODEL
●​ Stock price in years = E(1 + g) ×Mean industry PE ratio
●​ Dividend of Stock
4.​ FREE CASH FLOW
●​ Valuation per share= Present value of free cash flows−Liabilities / Shares
outstanding
5.​ CAPM
●​ = Rf+ B(Rm-Rf)
6.​ FACTORS AFFECTING STOCK PRICE
●​ Economic factors
○​ Changes in indicators of economic growth
○​ Changes in fiscal policy
○​ Changes in monetary policy
○​ Changes in exchange rates
●​ Market Factors
○​ Investor sentiment
○​ The January effect
●​ Firm-specific Factors
○​ Changes in dividend policies
○​ Changes in earning expectations
○​ Potential for acquisition
7.​ VAR MEASUREMENT
●​ Max % one-day loss=Expected daily return−[No. of std deviations from the
expected outcome×Std deviation of daily returns]
●​ Maximum one-day loss=Maximum percentage one-day loss×Amount invested
8.​ SHARPE INDEX
●​ Sharpe index = r -rf / standard deviation
●​ Higher SD = higher risk
●​ Higher sharpe = more expected return of risk
9.​ STOCK MARKET EFFICIENCY
●​ Weak-form Historical Data
●​ Semi-strong : all publicly available information
●​ Strong : all information, including insider knowledge.
10.​TREYNOR INDEX
●​ Treynor Index = r -rf / beta
●​ Higher SD = higher risk
●​ Higher sharpe = more expected return of risk
11.​FOREIGN STOCK VALUATION
●​ Cash flows in U.S. dollars= Cash flow in euros×exchange rate in dollars per
euro