CALLUM BLACK BLCCAL001 Tutorial group 4 Harvey Pamburai FTX3044F 2014 Tutorial 2 Due: Week beginning 3 March 2014

14 _____________________________________________________________ _ Question 1

Define the following concepts: Introduction (this is in the context of equity issuing) Although ambiguous (in the context of equity issuance) I will assume by introduction we are referring to the introduction and presentation of a privately owned company to the market, in preparation for its initial public offering or IPO to the public at large. This process is normally facilitated by one or many (they may form syndicates) underwriters (typically investment banks). Once the preliminary registration statement has been filed and a prospectus approved, by the JSE. Roadshows are then held periodically, where prospective companies market (under the auspices of the relevant underwriter) the company and present its prospectus to potential investors, and in so doing vet market demand for its shares. During this process, the aspiring public company engages in book-building and receives feedback from underwriters and potential investors as to their desire to purchase shares and at what price. This provides valuable pricing information, allowing the listing-company to get a better sense of at which price to issue their shares during the IPO. The IPO is the first time such shares are made publically available and as such constitutes a primary market. Offer for sale1 An offer for sale is a public invitation by a sponsoring intermediary, normally the underwriter, to buy new or existing securities. This offer is at either a predetermined price or at a price determined by a tender process, where investors state the price they are prepared to pay - after all such tenders have been received, the underwriter (in conjunction with the listing company) sets a final strike price, which all investors must pay. At the initial public offering, thereafter secondary market prices are governed entirely by supply and demand. This method of listing typically new shares is contrasted with an offer for subscription. Offer for subscription2 An offer for subscription, also known as a direct offer, is an invitation to the public by the listing company itself. Here the company facilitates most of the listing and completes all relevant listing documentation themselves (though some securities exchanges require that a financial intermediary such as an underwriter be used when a company wishes to list new shares on their exchange). Typically the shares are offered at a fixed price which prospective investors must commit to. However, should there be insufficient interest (and by that is typically meant a predetermined number of shares) in the issue at the given price, the entire share issue is aborted. This method of bringing a new company to the market is now rarely used.

1 2

Source: Reuters Financial Glossary Source: London South East Finance Glossary

CALLUM BLACK BLCCAL001 Tutorial group 4 Harvey Pamburai Rights offer3 A rights offering, also known as a rights issue is an offer to buy new securities by an already-listed company made to its existing shareholders. As such it is a form of a seasoned equity offering where already-listed companies are able to raise additional capital for expansion. Typically this offer takes the form of a shelf-offering where existing shareholders are given the opportunity to buy a specified number of shares, at a fixed price for a limited amount of time. Capitalization offer4 A capitalization offer is similar in nature to a rights offer, though differs in that the issue of the new shares in paid from the cash reserves of the company. As such, it functions as a means of turning additional cash reserves into equity, whilst rewarding existing investors. Its mechanics are akin to those of a stock dividend. The number of shares offered to each shareholder is typically allocated so as to maintain an existing shareholders proportion of equity. (5 x 2 marks) Question 2 You work as an equity analyst at XYZ asset managers and you have a very strong view on the share price of BHP Billiton PLC; it is substantially undervalued at R50 per share. Management has requested that you use leverage when you trade and thus you want to make use of margin trading. The margin requirements of your broker are a 50% initial margin for long and short trades and a 30% maintenance margin.

a) Are you going short or long on margin?

(2)

I am going long on margin as I believe that BHP Billiton PLC is undervalued, and that once the market gets hold of this information, that the price of BHP Billiton will reflect this. Thus I believe the share price will increase, and to profit from this I will buy long and make use of leverage, by doing so on margin (i.e. I will borrow half of the money used to buy the shares). b) If the share price rises to R80 per share what would be your margin percentage? Assume 1000 shares: Initially Assets R 50 000 (Shares) R 25 000 Liabilities R 25 000
3 4

Equity

http://moneyterms.co.uk/rights-issue/ http://www.cma.org.sa/Ar/Documents/Listing%20Rules%20Public%20Consultation%20GE.pdf

CALLUM BLACK BLCCAL001 Tutorial group 4 Harvey Pamburai

After price change: Assets R 80 000 (Shares) R 55 000 Liabilities R 25 000 Margin = Final Equity/Assets = R55 000/ R 80 000 = 68.75% (3) Equity

c) To what level can the share price fall before you will receive a margin call? (1000*P 25 000)/ 1000*P = 0.3 (1000*P 25 000) = 0.3* 1000*P = 300*P 700P = 25000 P = 25000/700 P = R35.71

(3)

Total: 18 marks

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