The types of securities underwriting are as follows:
- Underwriting – 1. Equity Underwriting 2. Debt Underwriting.
- Initial Public Offering (IPO)
- Private placements.
Underwriting is the concept of securing the price and selling a new issue of stocks and securities. The firms may take the risk and responsibility of selling a specific amount of stocks. The firms have to buy stocks among themselves if they are not able to sell stocks as planned.
Types of underwriting: There are two types of underwriting offers, namely, firm commitment and best efforts.
In firm commitment, the underwriter or investment bank is obligated to purchase securities if they are not able to raise the capital from the public. Contrary to firm commitment, the underwriter has no obligation in the best efforts offer. The underwriting fees are charged upfront and are usually around 0.5 percent of the total offer value.
IPO: When a privately held firm decides to raise the money from the public for the first time, it is termed as an IPO. If the company has already raised money from the public but wants to make another offer to augment its capital, then it is termed as a Follow-on Public Offer (FPO). The firms also prefer to raise the capital by issuing their stocks or bonds.
Steps of IPO: IPO management requires specialized skills since it is a lengthy process.
Any company that intends to adopt an IPO route has to incorporate the following key steps:
- Hiring the manager or choosing a committed investment bank: This step is incorporated after evaluating several investment banks based on their corresponding valuations and other factors, such as fee and credibility.
- Due diligence and drafting: The investment bank performs a due diligence and drafts, and then submits legal documents like S-1 to a regulatory body like SEC. This draft prospectus is also known as a red herring prospectus, which is a statutory requirement before a public issue of securities.
- Marketing: The Company and its bankers travel across the country to elicit the demand for its IPO by making pitches to institutional investors. These meetings and presentations are also known as road shows in which companies make presentations to potential investors and convince them to buy their securities.
IPO Pricing: The price at which an IPO is offered is very important as it reflects the valuation of a company and determines the demand for an offer. The investment banks arrive at a fair value through different methods as displayed here. The client firm and the investment bank decide whether to opt for a fixed price offer or a book building price discovery process. In a fixed price offer, the price of an offer is fixed. In contrast, the book building process involves a price band and demands investors to bid within a range.
Private Placements:In private placements, the debt or equity is sold to private investors rather than the public. The privately placed equity does not trade on the stock exchange. In private placements, the process for i-bank is similar to the sell-side M&A representation. The investors acting as venture capitalists in private placements seek a reasonable return on their investment. During the dot-com boom, many Internet startups were funded by venture capitalists. The investment bank acts as a mediator in identifying investors and negotiating the deal with them.
Structured products🙁 SP) are financial instruments or a combination of financial instruments designed to meet specific investor needs.
In structured products, the interest payments and redemption amounts depend on the movement of stock prices, indices, exchange rates, or future interest rates.
The focus of the structured products is often on engineering a specific cash-flow profile to achieve a specific purpose required by the client.
Structured products are usually broken down into their integral parts since they are made up of simpler components. Hence, valuation, assessment of their risk profile, and any hedging strategies can be done with ease. However, portfolio of these components should have the same payoff profile as the structured product. This facilitates analysis and pricing of the individual components.
The advantages of the structured products are that they have simple valuation rules, easy risk control, and easy hedging strategies.
The disadvantage of the structured products is that not all complex products can be broken down into simpler products. In such cases, complex numerical procedures need to be applied.