Question 1

One of the primary reasons for disbursing venture capital funds in installments is to:

Accepted Answer

Disbursing venture capital funds in installments allows the venture capitalist to closely monitor the progress of the startup and identify any issues or potential losses early on. This allows them to cut their losses and make better investment decisions, ultimately reducing their risk.

Question 2

Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day's trading, the issuing company's stock price had risen to $70. What is the cost of underpricing?

Accepted Answer

Cost of underpricing = ($70 - 43) × 3m = $81m

Question 3

Stock underwriters are:

Accepted Answer

Stock underwriters are typically investment banking firms that work with companies to coordinate and manage the process of selling new shares of stock to the public. They help determine the offering price, market the shares to potential buyers, and handle the logistics of the sale.

Question 4

Second-stage financing occurs:

Accepted Answer

Second-stage financing is a type of funding that occurs after a company has established its operations but before it is ready to make an initial public offering (IPO). This stage helps the company grow to a point where it can go public.

Question 5

What is the market value placed on a firm in which an entrepreneur invests $1 million and a venture capitalist invests $3 million in first-stage financing for a 50% interest in the firm?

Accepted Answer

Firm value = $3m/0.5 = $6m

Question 6

One strategy that appears to be used by certain underwriters to reduce the risk of marketing a stock is to:

Accepted Answer

Setting the initial stock price below its true value is a strategy used by underwriters to reduce the risk of marketing a stock. This approach makes the stock more attractive to investors, encouraging them to buy and ensuring the success of the stock issue.

Question 7

An underwriter issues a firm commitment to sell 1 million shares at $20 each, including a $2 spread. How much does the issuing firm receive if only 500,000 shares are sold?

Accepted Answer

Proceeds to firm = ($20 - 2) × 1m = $18m

Question 8

In return for providing funds, venture capitalists generally require:

Accepted Answer

Venture capitalists require an equity position in the firm, which means they become partial owners of the company in exchange for providing funds. This allows them to potentially earn a return on their investment if the company performs well in the future. Collateral or ownership of the entire firm is typically not required or expected. First right to all of the firm's assets may be negotiated in certain cases, but is not a standard requirement for venture capitalists.

Question 9

Underwriters are more likely to oversell new stock issues during:

Accepted Answer

Underwriters are more likely to oversell new stock issues during a bull market or market boom, when investor demand for new stocks is high and there is an expectation of high returns on investment. This can lead to oversubscription and an increase in the price of the new stock, benefiting both the underwriters and the issuing company. During a bear market or market crash, investor demand for new stocks decreases, and underwriters may struggle to sell their allotted shares, resulting in lower prices and potential losses. In a stable market period or an extremely volatile market period, the behavior of underwriters may vary depending on various factors. However, the most likely scenario for overselling new stock issues by underwriters occurs during a bull market or market boom.

Question 10

The direct expense of a stock issue includes the:

Accepted Answer

The direct expense of a stock issue primarily includes the underwriting spread and other expenses related to the issuance process, such as legal, accounting, and printing costs.

Question 11

Prospective investors are advised of a stock's potential risks by the:

Accepted Answer

The prospectus is a legal document provided by the issuing company that outlines the potential risks, financial information, and other relevant details for prospective investors. It is required by law to be provided before any initial public offering and is an important tool for investors to make informed decisions about whether to invest in a particular stock. The underwriter helps to facilitate the sale of the stock but is not responsible for providing information about potential risks. Underpricing laws do not specifically address the disclosure of risks to investors.

Question 12

Which one of the following is correct for stock issued under a firm commitment where the underwriter is to receive a spread of 8%?

Accepted Answer

In a firm commitment, the underwriter agrees to buy all the shares from the issuer and then sell them to the public. The spread of 8% is the difference between the price the underwriter pays to the issuer and the price at which the shares are sold to the public. If the underwriter cannot sell the shares at a high enough price, they may indeed suffer a loss, making option D correct. The spread does not guarantee profit, dictate a minimum sale percentage, or mean the underwriter receives shares as compensation.

Question 13

When underwriters offer a firm commitment on a stock issue, they:

Accepted Answer

When underwriters offer a firm commitment on a stock issue, they guarantee the net proceeds to the issuing firm, meaning they will buy the entire issue from the issuing firm at an agreed-upon price and assume the financial risk of selling it to the public.

Question 14

Blue-sky laws exist in order to:

Accepted Answer

Blue-sky laws are state regulations that aim to protect investors from fraudulent or deceptive practices in securities sales. These laws require companies to register their securities offerings and provide investors with full and accurate information about the investment opportunity. By doing so, they help prevent investment scams and ensure investors are informed and protected when making investment decisions.

Question 15

Which one of the following is correct if an underwriter is selling stock to the public at $40 per share, the underwriter receives a $3 per share spread, 2 million shares are sold, and the issuing firm receives $111 million from the underwriter?

Accepted Answer

Proceeds to firm = $111m = ($40 - 3) × Number of shares; Number of shares = 3m

Question 16

What percentage of direct expense is required to market stock if the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each?

Accepted Answer

Direct expense % = {$1m + [($43 - 40) × 3m]}/($43 × 3m) = 0.0775, or 7.75%

Question 17

Which one of the following is least likely to explain why entrepreneurs contribute their personal funds to start-up projects? Their contribution:

Accepted Answer

Entrepreneurs contribute their personal funds to start-up projects in order to signal their commitment and dedication to the project, to retain a portion of the firm's equity ownership, and to provide themselves with a direct financial incentive to expend effort in getting the business off the ground. Repaying debt held by venture capitalists would not typically be a primary reason for an entrepreneur's personal investment.

Question 18

The "winner's curse" is a reminder that:

Accepted Answer

The "winner's curse" refers to the tendency of successful bidders in auctions to overpay for an object due to emotions and the desire to win. This can occur when bidders don't accurately assess the value of the object, leading to them paying more than it is worth.

Question 19

The Securities and Exchange Commission will not permit securities to be sold:

Accepted Answer

Prior to approval of the registration statement, securities cannot be sold legally. This is to ensure that investors have access to accurate information about the investment and can make informed decisions. Overpricing, value guarantees, and shelf registrations are not factors in whether securities can be sold.

Question 20

Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day's trading, the issuing company's stock price had risen to $70. What is the total cost of issuing the securities?

Accepted Answer

Total cost = [($70 - 40) × 3m] + $1m = $91m

Quiz 15: How Corporations Raise Venture Capital and Issue Securities