Question

(a)Explain why some companies, having decided to “go public” choose to list their shares on an overseas market.

(b)Explain how investment banks make money when organizing an initial public offering (IPO) using the firm commitment method. Why might this contribute to IPO underpricing?

Answer 1

ANS :

(a) "Going Public " means a private company issues the IPO (Initial Public Offer). Via IPO private companies became publicly traded & owned entity. The main objectives for a company to "Go Public" are:-

1. To raise Fund / capital
2. To spread the risk of ownership amongst the large group of shareholders.

The Companies list their shares on an overseas market because of following reasons:

• Raising Equity capital - Through an IPO, company can sell stock on stock market and any one can buy them, that will leads to the weath maximisation to the company.
• Liquidity for employees & Investors - IPO increases the liquidity of stakeholders. It will be easier for the employees & the company for cash out. Investors who have invested so far may be able to sell or convert their shares into Cash or stocks.
• Branding & visibility - Once a company got publicly traded it would gain a social recognition inthe society.

(b) A Firm commitment is a promise to take a desired action within a certain point of time. This concept generally applies to a securities, where under-writer commits to buy the Unsold stock.

The primary function of an Investment bank is to serve as a sort of intermediary between corporations & investors through IPO ( Initial public offer). Investment bank provides underwriting services for new stock issues when a company decides to go public & seeks equity funding.

Investment bank approaches the company for under-writing services & Charges commission for bearing risk to the stocks, if they remain unsold within the specified period of time i.e providing Firms commitment.

IPO Underpricing

A Firm Commitment sell method contrasts with the best efforts & Stand-by commitment basis.

A Stand-by commitment takes best efforts by the underwriter to purchase the unsold IPO shares at the subscription price. In this the underwriter fees will be higher because the underwriter is exposed to the risk that the price it must pay for unsold shares will be at premium to the market price, due to weaker anticipated demand.