Initial Public Offering
Order Instructions:
SECTION A ( 2 pages minimum)
Initial Public Offering
One method utilized by companies to obtain the long-term capital necessary to run and grow their businesses is by providing the general public with the option to purchase stocks. The company’s first sale of stock is known as the initial public offering (IPO). When a company first offers the IPO, stocks are, on average, underpriced.
• Discuss the implications of such underpricing to established theories of market efficiency.
• Explain the role market efficiency might play in the underpricing theories presented by Loughran and Ritter.
Include a reference list hear 4 references minimum
SECTION B ( 2 pages minimum)
International Finance
Critics of the field of international finance charge that the field is simply “corporate finance with an exchange rate.”
• Critique this statement.
• Do you agree or disagree with it? Why?
• Justify your answer with specific details.
Include a reference list at the end hear 4 references minimum
Resources
• Article
• Loughran, T., & Ritter, J. (2004). Why has IPO underpricing changed over time? Financial Management (Blackwell Publishing Limited, Autumn), 33(3), 5–37. Retrieved from Business Source Premier database.
The authors of this article research the common practice of underpricing IPOs and how it has drastically fluctuated over the last several decades. They then propose and discuss three hypotheses to explain the level of changes that have occurred.
• Cohen, G., & Yagil, J. (2007). A multinational survey of corporate financial policies. Journal of Applied Finance, 17(1), 57–69. Retrieved from Business Source Premier database.
This article reviews findings from a six-country survey of corporate financial policies where it finds that investments were considered the most important financial decision and the internal rate of return was the most commonly used evaluation method.
• Ahern, K., & Weston, J. (2007). M&As: The good, the bad, and the ugly. Journal of Applied Finance, 17(1), 5–20. Retrieved from Business Source Premier database.
This article analyzes and rates the different theories surrounding the goals of mergers and acquisitions.
• Rhodes-Kropf, M., & Robinson, D. (2008). The market for mergers and the boundaries of the firm. Journal of Finance, 63(3), 1169–1211. Retrieved from Business Source Premier database.
In this article, the authors describe a new model they have developed that helps explain the process companies use for decision making on potential mergers and from using this model, they conclude that like-buys-like in terms of financial ratios.
• Statman, M. (2007). Local ethics in a global world. Financial Analysts Journal, 63(3), 32–41. Retrieved from Business Source Premier database.
In an increasingly global market, this article discusses the importance of evaluating ethics and fairness in different countries and seeking to improve the level at which is business occurs.
• Poulsen, A., & Stegemoller, M. (2008). Moving from private to public ownership: Selling out to public firms versus Initial Public Offerings. Financial Management, 37(1), 81–101. Retrieved from Business Source Premier database.
Throughout this research, the authors study over 1700 firms to determine the characteristics of those private companies that choose to sell out to a public company versus those who choose to become public by issuing an Initial Public Offering.
• Gondat-Larralde, C., & James, K. (2008). IPO pricing and share allocation: The importance of being ignorant. Journal of Finance, 63(1), 449–478. Retrieved from Business Source Premier database.
In making decisions on investing in IPOs, the authors discuss how banks and investors often form coalitions where both groups share the risk and in return the banks give lower-priced offerings to those in the coalition.
SAMPLE ANSWER
Section 1
Initial public offering (IPO) is mostly underpriced or below the market value. Usually, IPOs are in most cases underpriced because of issues relating to liquidity and the uncertainty on the level at which the stock is expected to trade. Low liquidity results to low uncertainty; hence, the need to under price to compensate investors for taking the risk. A company may be aware of the value of shares; however, the investor may not be aware. Therefore, the company must offer a lower price with the intent of encouraging investors. On the other hand, if IPO is offered at a higher price, investors are likely to reject. As such, the company is forced to give low prices to attract as many investors as possible (Gondat-Larralde & James, 2008).
IPOs are less understood by some investors. In fact, there are two types of investors, the informed and the uniformed. The informed investors are knowledgeable about the true value of shares while the uniformed only invest randomly without the knowledge on the value of shares. Usually, the price of fluctuates by the changes in demand as the stock is held constant. The demand is separated in two: informed and uniformed investor demand. If companies had IPOs that reflect their true value, then the uninformed investors would break or lose money as the informed investors would only invest in good IPOs. This would crowd out uninformed investors and be the only people turning profits. The law allows investment banks to allocate shares of oversubscribed that crowds out uninformed investors (Loughran & Ritter, 2004).
Ritter and Loughran stipulate that riskier IPOs are underpriced as compared to less risky ones. This attracts many investors as opposed to overpriced IPOs that discouraged informed investors. Further, it has been observed that IPOs stocks over the long seem to underperform the market. The long term underperformance is an anomaly that shows inefficient market hypothesis with inherent challenges. There is an argument that IPOs have a track record of earnings by the time they go public. The participants fail to realize that earnings growth reverts the stick prices before going public are quite high. It is claimed that SEOs have good returns three years before the issue. The past earnings are then corrected over time slowly (Schwert, 2003). To increase market efficiency, the uninformed investors should reduce uncertainties and gain the necessary information and increase market efficiencies. Analyzing of information can help traders to make informed decisions about IPOs.
Market efficiency refers to the availability of relevant information on stock prices is reflected. This view stipulates that it is not possible for investors to outperform the market since all the information is in stock prices. The concept of efficient markets relies majorly on the ideals of random walk that stipulates that price changes of today are independent of the past (Fama, 1998). This means that the flow of information should be uninterrupted and should not incur any cost. The information should reflect on the prices immediately. The price of tomorrow will change in anticipation to tomorrow’s news, which is unpredictable. Therefore, the prices of tomorrow are also unpredictable and random. This same view claims that efficient markets fails to allow investors to earn high profits without taking high risks.
It is arguable that market efficiency is the function of information cost. Information determines the distribution of IPOs. Thus, the analysis of information market is critical to understand anomalies that might emerge in the market.
References
Fama, E. F. (1998). Market efficiency, long-term returns, and behavioral finance. Journal of financial economics, 49(3), 283-306.
Gondat-Larralde, C., & James, K. (2008). IPO pricing and share allocation: The importance of being ignorant. Journal of Finance, 63(1), 449–478. Retrieved from Business Source Premier database.
Loughran, T., & Ritter, J. (2004). Why has IPO underpricing changed over time? Financial Management (Blackwell Publishing Limited, Autumn), 33(3), 5–37. Retrieved from Business Source Premier database.
Schwert, G. W. (2003). Anomalies and market efficiency. Handbook of the Economics of Finance, 1, 939-974.
Section 2
International finance is a body that deals with monetary economics at international levels. It is a body of financial system that protects the framework of finance institutions and legal agreements. The evolution of international finance has led to the development of central bank and other institutions such as multilateral agreements. The central bank is the major player in international finance (Ocampo, 2007). It is charged with the role of currency exchange between various countries. It determines the value of differing currencies in differing countries in relation to another. The foreign exchange rate is open and is determined by many factors. Buyers and sellers must know the value of currency of the countries they are trading with in order to determine the price and exchange rates. The international traders must also understand the fluctuations in the exchange rates.
International finance determines the value of currency for each country depending on factors. The currency for a particular country has more value if its demand is greater than the supply. On the other hand, when the demand is less that supply, the currency becomes weaker. This does not mean that people will not value that money anymore; rather, they prefer keeping their wealth in another form. The international finance helps people and corporations to determine when to trade and make more profits at international levels depending on the value of currency of the trading countries. The transaction demand for money leads to increased demand for stronger currency. This demand for transaction is determined by the country’s level of GDP, employment and business activities. The lesser the employment level, the less the people will get involved in trade and transactions; hence, weaker currency. Other factor that the international finance is charged with is the adjusting of interest rates. The higher the interest rates, the more the demand for currency and vice versa. For carrier companies, information on exchange rates is crucial in carrying out businesses. Therefore, such companies need to seek the expertise of international finance in order to maximize profits and determine when to trade and when to hold on (Greuning, Scott & Terblanche, 2011).
Even though the exchange rate is crucial in financial market of international communities, this does not mean that corporate finance is all about exchange rates. The basic domestic corporate finance is crucial in the foreign exchange. Likewise, international corporations are greatly influenced by cultural, political, and environmental regulations and changes (Madura, 2011).
Exchange rate is a process in which the pricing system and currency exchange takes place at international levels. Exchange rate changes over time depending on the changes in domestic and international market. Corporations at international levels use critical information availed in the foreign exchange market to help in capital budgeting and making critical decisions necessary for future growth. The managers in the financial sector accept decisive factor of market efficiency and act in the interests of all shareholders. In cases where the exchange rate matters most, international finance corporations purchase power parity to balance the risks inherent in exchange rates and capital budgeting.
It is true that international finance deals with currency exchange; however, there are many more roles than that. It is responsible for advising international traders in order to determine when it is best to trade (Sercu, 2009). As such, international finance is not just exchange rate.
References
Greuning, H. ., Scott, D., & Terblanche, S. (2011). International financial reporting standards: A practical guide. Washington, D.C: World Bank.
Madura, J. (2011). International Financial Management. Florence, KY: Cengage Learning, Inc.
Ocampo, G. J. A. (2007). International finance and development. New York, NY [u.a.: Zed Books.
Sercu, P. (2009). International finance: Theory into practice. Princeton, N.J: Princeton University Press.
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