Issuance Qs Q1) in Term Of, Issuance

Issuance Qs

Q1) in term of, Issuance Costs:

The cost of selling stock to the public list below which contains 6 categories as follow:

Gross Spread

Other direct expenses

Indirect expenses

Abnormal returns

Underpricing

Green Shoe option

Explain how will each category ( cost of issueing security) will affect raising capitals ( positively or negatively)

Gross Spread: This refers to the simple difference between the underwriting price of each share of stock (that is, the price the issuing company actually receives for the stock) and the price the underwriters offer to the public (generally the estimated market value of the stock) (Minarss, 2003; Carey, 2009). This is a cost to the company, but the profits to the underwriters provide their incentive for performing the underwriting tasks, and so this spread is necessary (Minarss, 2003; Carey, 2009).

Other Direct Expenses: Other direct expenses involved in issuing stock range from human resources costs (i.e. The labor hours involved in performing necessary audits, paperwork, communications, etc.) to fees to the exchange where the stock is to be sold to a host of other miscellaneous expenses (Minarss, 2003). These are simple costs to the company and do not really affect capital generation but do require capital themselves, and so they should be reduced as much as possible (Minarss, 2003).

Indirect expenses: Indirect expenses of issuing stock involve any expense that is not an actual line-item cost (i.e. direct expense) of the issuance, and so includes things like the spread and underpricing while not including any thing like exchange fees or human resources costs (Minarss, 2003; Carey, 2009). These costs are often unpredictable, and while they should be contained it is often difficult for a company to do so (Carey, 2009).

Abnormal returns: As the name implies, this cost area refers to returns on the stock price that are abnormal -- either lower or higher than expected. A lower-than-expected return doesn't really affect the capital raising of the company, or could perhaps be seen as a benefit; the company gets whatever price is agreed upon by the underwriters (Carey, 2009). A higher-than-expected return means that the company could have received more capital -- a higher price -- from their stock issuance, and so in a sense hurts its capital raising capabilities.

Underpricing: Underpricing refers to selling a stock below its market value price, and generally only occurs in IPO settings. Somewhat like the gross spread, this is now seen primarily as a means of incentivizing the underwriters, who can provide incentives to major investors that are clients of these underwriting companies to make the initial stock purchases (Carey, 2009). This essentially hurts capital raising for the company by making a lower-than-market price the effective price for the stock issuance, but might be necessary in the current system in order to allow an IPO or other large stock issuance to move forward (Carey, 2009).

Green Shoe option: This is the ability given to underwriters to sell more stock than in initial IPO or stock issuance should demand prove higher than expected, which generally is good for the capital raising ability of the company and also has other market effects seen by many as desirable, namely price stabilization (Minarss, 2003).

Q2) In term of raising capital, explain Green Shoe provision "and why it is important?

The greenshoe or over-allotment option of many IPOs and stock issues allows the underwriter to issue more shares at the offering price if demand for the stock in the market causes the price to climb rapidly and/or fluctuate (Minarss, 2003). This is good for capital raising because if demand is higher than expected, the company is able to raise more capital rather than having all of the demand-generated profits going to the investors trading the already-sold shares.