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How securities are traded - How firms issue securities

7 important questions on How securities are traded - How firms issue securities

What is the primary market?

New issues of stocks, bonds, or other securities typically are marketed to the public by invest- ment bankers in what is called the primary market.

What is the difference between an IPO and seasoned equity offering?

There are two types of primary market issues of common stock. Initial public offer- ings, or IPOs, are stocks issued by a formerly privately owned company that is going public, that is, selling stock to the public for the first time. Seasoned equity offerings are offered by companies that already have floated equity.

What is the difference between a public offering and private placement?

A public offering refers to an issue of bonds sold to the general investing public that can then be traded on the secondary market. A private placement refers to an issue that usually is sold to one or a few institutional investors and is generally held to maturity.
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What is the firm commitment?

In a typical underwriting arrangement, the investment bankers purchase the securities from the issuing company and then resell them to the public. The issuing firm sells the securities to the underwriting syndicate for the public offering price less a spread that serves as compensation to the underwriters. 

What are private placements?

In this case, the firm (using an investment banker) sells shares directly to a small group of institutional or wealthy investors. Private placements can be far cheaper than public offerings.  On the other hand, because private placements are not made available to the general public, they generally will be less suited for very large offerings. Moreover, private placements do not trade in secondary markets like stock exchanges. This greatly reduces their liquidity and presumably reduces the prices that investors will pay for the issue.

What are roadshows and the two purposes of road shows, the book and bookbuilding?

In roadshows they travel around the country to publicize the imminent offering. These road shows serve two purposes. First, they generate interest among potential investors and provide information about the offering. Second, they provide information to the issuing firm and its under- writers about the price at which they will be able to market the securities. Large inves- tors communicate their interest in purchasing shares of the IPO to the underwriters; these indications of interest are called a book and the process of polling potential investors is called bookbuilding. 

Why do investors truthfully reveal their interest in an offering to the investment banker?

Shares of IPOs are allocated across investors in part based on the strength of each inves- tor’s expressed interest in the offering. If a firm wishes to get a large allocation when it is optimistic about the security, it needs to reveal its optimism. In turn, the underwriter needs to offer the security at a bargain price to these investors to induce them to participate in book-building and share their information. Thus, IPOs commonly are underpriced com- pared to the price at which they could be marketed.

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