Question

Which of the following are indirect costs of issuing securities? I. abnormal returns II. underwriters' spread III. underpricing IV. legal fees

Answer 1

Indirect costs are: I. abnormal returns, III. Underpricing.

Underwriter's spread is a gross spread that is paid by the issuer to the underwriter - which is the difference between the offer price and the price issuer receives. This is a direct cost by definition, since this forms as a compensation to the underwriter.

Legal fees is also directly paid for managing the legal aspects of the issuance. Since, it is a payment, it is also a direct expense.

Indirect expenses are not reported on prospectus. They are more economic costs rather than actual cost paid.

Abnormal returns - This generally happens in case of an already public company raising another round of funds through more stock issuances. In a seasoned issue of stock, the price of existing stock drops on average by 3% on announcement of the issue. This is abnormal return. Since, it is not a direct cost paid by company, it is called an indirect cost.

Underpricing - For initial public offerings, the economic losses that arise from selling the stock below the true value is called underpricing.

Clearly, two options refer to compensation/payment being made - direct expenses.

Two options refer to cost from an economic perspective (rather than actual cost) - indirect expenses