Finance Case

1. When do companies use venture capital financing? What is the role of venture capitalists (what services do they provide and what benefit do they have)?

- Venture capital is used at when firms are young with high growth potentials and high risk of failure

- Role of venture capitalist: Provides financing in stage, advice and infrastructure

- The management of venture capital firms receives a fee (usually around 2%) plus a percentage (share) usually around 20%. This is called the carried interest.

2. List some of the important reasons for a firm to go public.

- Raising money

- Stock is a readily available measure of performance (can be used for management incentives)

- Cash-in method by initial investors (including venture capitalists)

Other reasons of going public (see figure 16.2 of your book). For example to enhance the reputation of the company, broaden the base of ownership, allow initial owners to diversity, minimize cost of capital etc

3. Explain the steps of an initial public offering and the role of the underwriters in the process.

Steps:

1. Pricing the issue

2. Road-show

3. Creating book of potential orders

4. Shares offered to the public

Underwriters are investment companies ("stockbrokers") that arrange the procedure for the IPO of firm. This includes:

- Financial and legal advice ( Registration statement and prospectus preparation, pricing the new issue)

- Guaranteeing the issue by buying the issue and reselling to the public with a spread (usually a syndicate of underwriters is formed)

- Advertising the new issue (road-show)

4. What are the costs of a new stock issue?

- Spread, i.e., the difference between the actual value and the value received by underwritter

- Underpricing of stock

- Adminstrative costs (preparation of prospectus, legal and accounting advice etc)

5. What is a warrant? Explain the differences between a warrant contract and simple call option.

* Warrants are a special type of a call option

* A call option is a financial contract that gives the right (and not the obligation) to an investor to buy a stock (S) at a future date (T) at a predetermined price X

* Payoff at T: max (S(T)- X, 0)

* A warrant is special type of call option with the following two important differences:

- A warrant is issued by the firm itself and the firm raises money at the issue (while a call is a side-bet sold by an investment bank)

- At warrant exercise, there is value dilution. Value dilution is caused because exercising the warrants increases the number of shares available and thus reduces the price per share

6. Explain the main differences between discriminatory and uniform auction procedures.

There are 2 types of auctioning Discriminatory and Uniform