DATA GATHERING

Sources of information: o Industry analysis o Government publications  NAICS  Census  PPI  CPI o Surveys o Industry studies o Trade press/trade associations o Business and financial press  WSJ  Barrons  Financial Times  Etc. o Business information services  Capital IQ  SNL Financial Reports, forms and schedules o 10-K and 10-Q o 8-K reports made to the SEC if an event that would materially affect the issuers financial condition or share price, including:  Business and operations  Financial information  Securities and trading markets  Accountants and financial statements  Corporate governance and management  Asset-Backed Securities  Regulation FD  Financial statements and exhibits  Other events o Schedule 13D requires anyone who acquires 5% or more of an issuers equity securities to notify the issuer, the exchange where the securities are traded, and the SEC within 10 days o Schedule 13G an alternative to Schedule 13D filed usually by institutional investors that have no intention to influence or control the issuer o Schedule 13F requires quarterly filings when institutional investment managers exercise investment discretion over at least $100 million in equity securities o Proxy Statements on Form 14A contains information that will be voted on during the annual shareholder meeting o Beneficial Ownership Reports Form 3,4,5 required of insiders that own stock Registration Statements o S-1 used for IPOs o S-3 short form registration available for WKSIs with at least $75 million in public float o S-4 if securities are to be issued in connection with a merger o Proxy Statements required in merger combinations, contains:  Press release  Definitive agreement  Fairness opinion  Capital structure of transaction

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Going Private Transactions: o Schedule 13E-3 Tender Offers o Schedule 14D-9 or Schedule TO Communications with research department: o IB department is restricted from exercising any control whatsoever over its research department o Prohibit communications between a members research and investment banking departments other than to verify information or check conflicts o Have to route written communication through compliance department o Cant threaten to retaliate for adverse, negative, or unfavorable research reports that may be detrimental to the members current or prospective investment banking business

ECONOMICS
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Gross National Product measures the total value of all goods and services produced by a national economy (includes goods produced in and out of the U.S. by U.S.-based companies) Gross Domestic Product measures the output of goods and services produced by labor and property located in the U.S., without regard to the origin of the producer o Real GDP adjusted for inflation using constant dollars CPI measure of inflation that measures the prices of a fixed basket of goods bought by a typical consumer Inflation: o Nominal rate less inflation rate = real rate  Ex: bond earns 10% (nominal rate) and inflation is 3%, real rate = 7% Disinflation reduction in the rate of inflation Stagflation prolonged period of a high rate of inflation at the same time as a high rate of unemployment Leading Economic Indicators precede the upward and downward movements of the business cycle o Average workweek for production workers in manufacturing o Average weekly initial claims for state unemployment insurance o New orders for consumer goods and materials o Vendor performance (companies receiving slower deliveries from suppliers) o Contracts and orders for plant and equipment o New building permits for private housing units o S&P 500 o Money Supply (M2) o Change in credit outstanding for business and consumer borrowing o Interest rate spreads, 10-year Treasury bonds less federal funds o Index of consumer expectations Coincident Economic Indicators mirror the movements of the business cycle o Employees on nonagricultural payrolls o Personal income less transfer payments o Index of industrial production o Manufacturing and trade sales Lagging Economic Indicators change after the economy has moved through a given stage of the business cycle o Average duration of unemployment o Relationship of inventories to sales, manufacturing, and trade o Labor cost per unit of output for manufactured goods o Average prime rate charged by banks o Commercial and industrial loans outstanding

Relationship of consumer installment credit to personal income CPI for services Market Capitalization o Large-cap = more than $10 billion o Mid-cap = $2 billion to $10 billion o Small-cap = $300 million to $2 billion o Micro-cap = $50 million to $300 million o Nano-cap = below $50 million Economic Theory o Keynesian:  States that government intervention in the economy is necessary for sustained economic growth and stability  Further states that government should use fiscal policy to combat the effects of inflation and deflation  Fiscal policy governments use of taxation and expenditure programs to maintain a stable growing economy o Supply-Side Economics:  Places an emphasis on reducing taxes and the size of government to stimulate the economy o Monetary Policy:  Attempts to control the supply of money and credit in the economy. This in turn will affect interest rates causing an increase or decrease in economic activity  Money supply  M1 = currency in circulation + demand deposits + other checkable deposits  M2 = M1 + money market deposit accounts + savings and relatively small time deposits + balances at money funds + overnight repurchase agreements at banks  M3 = M2 + large time deposits + term repurchase agreements at banks and S&Ls (no longer published by the FRB) Tools of the Federal Reserve Board (FRB) o Setting reserve requirements  Lowering reserve requirements banks extend more credit money supply increases (opposite for raising reserve requirements)  Multiplier effect rate at which banks can create new money by relending deposits and, in turn, creating new deposits o Setting the discount rate  Decreasing the discount rate encourages borrowing, which expands the money supply  Only rate directly set by the FRB o Implementing open market operations  Federal Open Market Committee (FOMC) oversees the FRBs buying and selling of U.S. government securities in the secondary market  Most effective and frequently used tool of monetary control  If the Fed buys securities, it pays for them with funds that are ultimately deposited in commercial banks. This causes deposits at banks to increase and thus adds to the funds available for loans. The result is an increase in reserves  If the Fed sells securities to banks and dealers, this will tighten the money supply  Repurchase agreement (repo) contract entered into by the Federal Reserve to purchase U.S. government securities from dealers, at a fixed price. This practice increases bank reserves as it is lending money  Reverse repo (matched sale) occurs when the FRB sells securities to dealers with the intention of buying the securities back at a future date. This has the short-term effect of absorbing funds from the money supply o Setting margin requirements
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By increasing margin requirements the FRB reduces the amount of brokers and banks that may lend, causing the money supply to tighten  Least effective method that the FRB uses to control credit because it only affects securities market transactions o Utilizing moral suasion (jawboning)  Fed exerts its influence through the public media in effort to control the money supply


Activity Raise bank reserve requirements Raise the discount rate Raise the margin requirement Sell securities in the open market Lower bank reserve requirements Lower the discount rate Lower margin requirements Buy securities in the open market

Effect on Money Supply & Credit (Loan) Availability Decrease Decrease Decrease Decrease Increase Increase Increase Increase

Impact on General Interest Rate Levels Raise Raise Raise Raise Lower Lower Lower Lower

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Intermediation the ability of financial intermediaries (such as banks) to attract deposits and, in turn, extend credit Disintermediation the process by which investors withdraw funds from banks and seek high-yielding investments elsewhere Investment Objectives o Growth strategy investing in companies or industries that are expected to grow faster than those of its peers  Above-average earnings or revenue growth  Pay little to no dividends  Higher risk (high P/E ratios)  Higher potential for capital appreciation o Value investing investing in companies that are underpriced from a fundamental or financial point of view  Low price-to-book  Low P/E  High dividend yield o Growth at a Reasonable Price (GARP) combines value and growth. The investor is seeking companies with good growth potential that seem to be undervalued  Low P/E  Low PEG  Low price-to-book Investment risk o Capital risk risk that investors will not fully recover their entire investment o Credit risk risk that an issuer may be unable to pay interest and/or principal when due on fixed income securities o Liquidity risk the investors ability to sell a security quickly at a reasonable price compared to recent transactions o Inflationary (purchasing power) risk risk that, due to inflation, the value of a dollar will decline over time, causing a decline in purchasing power

Interest-rate risk risk that if interest rates rise, the price of an investors bond holdings will decline o Exchange-rate risk risk that the income received from foreign investments will be worth less due to currency fluctuations o Market (systematic) risk risk that a securitys value may decline, not because of a change in the specific company, but due to a decline in the market as a whole (measured as Beta)

Investment strategies: o Momentum trading describes a situation where prices are moving in a certain direction and there is a high level of trading volume o Short sales involve the sale of a security that is not owned by the seller o Market neutral used to describe an attempt to profit by buying securities while, at the same time, selling short other securities within the same (or similar) sector o Arbitrage investing objective is to profit by identifying two related but mispriced securities o Index investing passive investing designed to minimize transaction costs and taxable events o Distressed investing involves investors searching for companies and/or securities that are in default, bankruptcy, or moving in that direction

FINANCE
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Balance Sheet Income Statement Cash Flow Statement Special Issues in Accounting: o Depreciation  Straight Line: typically used for book purposes  MACRS: required by IRS under this system the assets are fully depreciated and have no salvage value  Double-Declining Balance: only accelerated depreciation method allowed by the IRS o Accounting for investments in stock:  Cost method: up to 20% of company ownership  Equity method: 20-50% of company ownership  Purchase method: over 50% of company ownership  Mandatory for use in a cash deal  Viewed as an acquisition of new assets  Book value is marked to market  Goodwill is created if purchase price exceeds fair value of assets acquired  Minority interest  Balance sheet = liability  Income statement = other expense to reduce net income by the amount of company earnings not owned by the parent o Goodwill Impairment  Step One: identify potential impairments by comparing fair value to book value  Step Two: If carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to the excess and presented on a separate line item on the income statement o Stock dividends vs. stock splits Stock Split Stock Dividend No change Increase

Paid in capital

Retained earnings No change Decrease Par value No change Increase Par value per share Decrease No change Inventory  Cost of goods available for sale  Cost of goods sold  Periodic inventory system (physical counts)  Specific identification method  First In, First Out (FIFO)  Last In, Last Out (LIFO)  Weighted Average o Restructuring charges shown on the income statement in the operating section as well as in the footnotes of a companys financial statements Financial Statement Analysis: o Turnover Ratios  Asset Turnover = Sales/Average Assets  Receivable Turnover = Sales/Average Receivables  Payables Turnover = COGS/Average Payables  Inventory Turnover = COGS/Average Inventory o Liquidity Analysis Ratios  Current Ratio = Current Assets/Current Liabilities  Quick Ratio (Acid Test) = (Cash and Equivalents + Receivables)/Current Liabilities o Probability Analysis Ratios  EPS  Fully diluted EPS  EBITDA margins  Profit margins  Return on assets = Net Income/Average Assets  Return on equity = Net Income/Average Equity  Return on invested capital = (EBIT * (1-T))/Invested Capital  Invested capital has many different calculations, including  Fixed Assets + Current Assets Current Liabilities Cash  Fixed Assets + Noncash Working Capital  Total Assets Noninterest Bearing Current Liabilities + Excess Cash  Days sales outstanding (DSO) = Accounts Receivable / (Net Sales/365) o Capital Structure and Capital Markets Analysis  Debt-to-total capital = Debt / (Debt + Equity)  Debt-to-equity = Debt / Equity  Debt-to-EBITDA = Debt / EBITDA  Dividend payout = Dividends / Net Income  Interest coverage = EBIT / Interest
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GENERAL SECURITIES
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Activities allowed by nonregistered persons: o Extend invitations to firm-sponsored events o Inquire whether a prospective customer wishes to discuss investments with a registered rep o Inquire whether a prospective customer wishes to receive investment literature from the firm Manipulation

Fraudulent to withhold material information from a client Wash sale = purchasing and sale of securities without any beneficial change of ownership (buying stock from one broker and selling from another at the same price) also called painting the tape o Use of pro forma financials is considered fraudulent unless the assumptions are clearly laid out SEC Rule 10b-18 o Controls how an issuer or affiliate may buy its own stock in the secondary market (does not apply to public tender offers) o 10b-18 Safe Harbor  Use of one broker dealer to make purchases on any trading session  Avoid making purchases at certain times of day  Cant be the first transaction of the day  Cant be during the last half-hour of normal trading day (unless actively traded, then cant be within last 10 minutes)  Limit the bid or purchase price  Cant be higher than the highest independent bid or the last independent transaction price  Limit the amount of stock purchased on any single day  Total volume purchased may not exceed 25% of the ADTV for that security  Once a week you can effect one block purchase in excess of 25% if no other 10b18 purchases are made that day NYSE Rule 77 o Prohibits dealings and activities for members on the Floor from:  Buying or selling securities on stop above or below the market  Buying or selling securities at the close  Buying or selling dividends  Betting on the course of the market  Buying or selling privileges to receive or deliver securities Insider Trading o Unlawful, in connection with the purchase or sale of any security, to:  Employ any device, scheme, or artifice to defraud  Make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made not misleading  Engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any person o Tippers and tippees o Insider trading legislation as a result of 1980s scandals:  Insider Trading Sanctions Act of 1984 (ITSA)  Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA) o Establishment of procedures:  System for monitoring employees personal trading and trading in firm proprietary accounts  Restriction or monitoring of trading in securities where the firm has access to inside information  Procedures to restrict access to files containing confidential information, including the establishment of information barriers  Education of employees regarding insider trading issues o Information barrier procedures  Preventing the transmission of confidential information from one department to another within a broker-dealer (Chinese walls)  SEC has not mandated any particular system o Restricted and Watch Lists:
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Lists apply to both employees and to solicited transactions with customers Restricted list is distributed to all employees Watch list is only known by senior management o Consequences  Civil: up to 3 times the amount of gain, or loss avoided  Criminal:  Individuals: up to $5 million fine and up to 20 years in prison for each violation  Corporations: up to $25 million fine for each violation  Bounties: the Act allows payment of bounties, but limits to no more than 10% of the penalty Office of Supervisory Jurisdiction (OSJ) o Any location at which one or more of the following activities takes place:  Market-making and/or order execution  Structuring of public offerings or private placements  Maintaining custody of customers funds and/or securities  Final acceptance of new accounts  Review and endorsement of customer orders  Final approval of advertising or sales literature  Responsibility for supervising other branch offices Branch offices o Where one or more of the firms associated personnel regularly conduct the business of effecting transactions in, or inducing or attempting to induce the purchase or sale of any security o Do not include:  Nonsales office (back-office and operations offices)  Locations of convenience  Floor of an exchange  Temporary offices  Location primarily used for nonsecurities business and from which less than 25 securities transactions are effected annually Record keeping o Includes email o Required to maintain records for 3 years Anti-Money Laundering (AML) o All member broker-dealers are required to have an annual AML test for employees o Penalties: up to 20 years in prison and $500,000 or twice the amount of money involved, whichever is more Customer Identification Program (CIP) o U.S. Citizens: client name, date of birth, address, and taxpayer ID o Non-U.S. Citizens: all of the above and at least one of the following:  Taxpayer ID  Passport number and country of issuance  Government issued document with a picture that provides proof of nationality Accounts for employees of other member firms: o Notify the employer member in writing of the intention to open the account o Send duplicate confirmations and statements to the employer member, if requested o Notify the person opening the account that these procedures will be followed Private securities transactions o Selling away transactions outside the regular scope of a persons employment  If compensated for the transaction, the member must specifically approve the transaction in writing  If no compensation, the member may require the person to adhere to specific conditions Guarantees never guarantee against losses in any way
  

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Sharing in accounts is acceptable, provided: o Employee has made a financial contribution o Sharing of profits and losses is in direct relationship to the employees financial contribution o Employee has obtained written permission from the member firm carrying the account Borrowing and lending with customers, unless one of the following is met o Customer and registered person are immediate family members o Customer is a financial institution regularly involved in the business of extending credit o Both parties are registered with the same firm o Loan is based on a personal relationship between the customer and registered person o Loan is based on a business relationship independent of the customer-broker relationship o If the last 3 prevail, the firm must approve prior to lending activity Gifts: o No gift greater than $100 per recipient per year to people employed by other member firms o Excludes occasional meals, tickets, reminder advertising, and expenses related to legitimate business travel Members are required to maintain a separate file of all written complaints in each office of supervisory jurisdiction Quarterly reports: o Required to provide statistical and summary information about customer complaints on a quarterly basis, unless no complaints were received during the quarter Resolving Problems: o Code of Procedure: describes FINRAs disciplinary process  Sanctions: a Hearing Panel may impose the following  Censure a member firm or associated person  Fine a member firm or associated person (no limit)  Suspend the membership of a firm or suspend the registration of a person  Expel a member firm or cancel its membership; revoke or cancel the registration of an associated person  Suspend or bar an associated person from association with any member firm  Impose any other fitting sanction  Cannot sentence anyone to prison  Appeals: respondent has 25 days to file an appeal  Hearing Panel National Adjudicatory Council (NAC) SEC Federal Courts o Code of Arbitration: requires that disputes between members and other members be settled by arbitration Mediation A negotiation process Arbitration A hearing process at which the two parties present their cases

Mediator attempts to facilitate a resolution does Arbitrator imposes a binding settlement not impose a settlement Either party can withdraw Parties cannot unilaterally withdraw Informal discussion process More formal process testimony under oath Arbitrator decides the outcome it is more of a win Settlement must be mutually agreeable or lose decision Parties must be willing to see strengths in other Useful where the position of one or both parties is sides position inflexible Often more expensive and time-consuming than Can be less costly and quicker than arbitration mediation, but usually cheaper and quicker than

Process is private, settlement is confidential

litigation Hearings are private, decision is public

MERGERS & ACQUISITIONS (M&A)

y y y Merger two companies join together and reorganize as a new entity. Shareholders from both companies surrender their stakes and are given ownership in a newly created entity Acquisition the buyer acquires the target company for either cash and/or stock. The target company ceases to exist in a legal sense. Deal Participants o Sellers o Buyers  Strategic  Financial Which buyer will pay more? In normal markets Strategic buyers will pay more o Synergies o Access to low cost of capital (credit or stock) Valuation o Comparable companies analysis o Precedent transaction comparables o DCF o Pro forma o LBO Deal structure o Asset Deal Buyer wants assets because of tax advantages and step up in basis, ability to leave behind liabilities o Stock Deal Seller wants stock deal because of tax advantages and ability to leave behind all liabilities Transaction currency o Cash buyout simplest type of deal  Provides certainty for the seller  Creates an immediate taxable event for the seller o Acquisition with stock targets shares are tendered for shares of the acquiring company  Does not create an immediate tax liability for the sellers (assign cost basis of their old position to the new shares)  Constant (fixed) share exchange agreement buyer offers a fixed ratio of its shares regardless of any price fluctuations that may occur in either stock between signing and closing y If the acquirers shares rise in value preclosing, the target is effectively paid more and, if the price declines, the seller receives less  Fixed value agreement the deals total dollar valuation is guaranteed by altering the number of shares issued to the target y Collars negotiated parameters which set a lower range (the floor) and an upper range (the cap) on the acquirers stock price, to give both parties high and low end valuations for the transaction  Material adverse change (MAC) clauses  Floating collar buyer and seller agree to a fixed exchange ratio provided the acquirers share price remains within the collar range

Fixed value (payment) arrangement the buyer guarantees to the target firms shareholders that they will be paid a fixed dollar value in stock, provided the buyers shares remain within the collar Transaction Types o Consolidation merger Brand new company is formed for the purpose of buying both companies and combining them under the new entity o Spinoffs When a company is seeking to divest a division  Each shareholder of the parent retains her original shares, but is also given shares in the newly created entity  No immediate tax consequences o Splitoffs Corporation is split into pieces  One group of shareholders will ultimately own shares solely in the original parent, while the other group will own shares solely in the split-off entity  Used to split corporate assets between groups of feuding shareholders  No tax liability is created o Reverse Merger Private company buys a public shell company with the acquirers shareholders swapping their shares for a majority stake in the publicly traded corporation  Doesnt have to be a shell corporation o Triangular mergers Involves three entities (buyer, target, subsidiary owned by buyer)  Forward triangular subsidiary merges with the seller. The legal structure that was the selling entity is liquidated while the subsidiary survives  Reverse triangular subsidiary merges into the seller with the target company as the surviving entity y Used when selling entity has significant contracts in place that would not survive the acquisition Merger Types o Vertical merger transaction between two firms at different levels of the production chain o Horizontal merger combining two companies that are in direct competition with one another o Product extension merger transaction involving two companies that sell different, but somewhat related products o Market extension merger combination of two companies that sell the same products or services into different markets o Conglomerate merger when buyer and seller companies sell products in completely different markets Hostile Deals: Takeover Defenses o Shareholders rights plan target company issues rights to existing shareholders to acquire a large number of new securities o Staggered boards staggering board election to prevent hostile takeovers o Supermajority approvals requiring the vast majority of BOD members to agree on significant issues such as mergers or the sale of a firm o Golden parachutes severance payment made to a senior officer in the event of a takeover or change of control Seller Initiated Transactions o Controlled Auction o Full Public Auction Auction Process o Sign the engagement letter o Develop contact/prospect list o Create the teaser o Confidentiality agreement o Confidential information memorandum

o Distribution of initial bid procedure letter o Creation of the data room o Conducting management presentations o Collection of initial bids o Evaluation of initial bids o Term sheet creation o Final bid procedure letter o Final bid placement o Selecting the winner o Signing definitive agreements o Creation of fairness opinion(s) o Signing and closing the deal Distressed Sellers o Chapter 11 Bankruptcy (reorganization) o Chapter 7 Bankruptcy (liquidation) Tender Offers o Buyer goes directly to the shareholders when seeking to acquire shares in a company o Often part of a takeover strategy or an attempt to get sufficient votes to gain Board representation o Must specify the period the offer is extended for, the price, and quantity of shares the buyer wants to purchase o Can be initiated by the company itself to acquire its own securities o SEC rules require tender offers be conducted in a fair manner, including the following rules:  Shareholders must be notified no later than 10 business days after the tender is made  Management must advise shareholders of a recommendation  Must generally be held open for at least 20 business days from the time they are announced to security holders  If the offer is amended, the revised offer must remain open for at least 10 more business days  In order to extend the expiration, public announcement must be made on the earlier of (i) 9am EST on the day after expiration or (ii) opening of the exchange on the next business day  Fraudulent to not pay the tender or to fail to return the securities tendered o Rule 14e-5 no open market purchases during the tender period  Buyers engaged in a tender cant buy additional shares in the open market once the tender has commenced  Exceptions y Purchases by the dealer-manager or its affiliates on an agency basis y Purchases on a principal basis, provided the dealer-manager and its affiliates are not market makers y Purchases by an affiliate of the dealer-manager, if the affiliate maintains and enforces written policies and procedures that are designed to prevent the flow of information, and the purchases are not made to facilitate the tender offer  Securities can be tendered only if the investor is long the stock, or long an equivalent security o Rule 14e-1 extension of time period  May not extend unless done in a press release or other public announcement o Rule 14d-9 notification of tender  Company must notify shareholders within 10 business days  Schedule TO must contain the following (used as the basis for the proxy statement): y Summary term sheet y Subject company information

y Identity and background of filing person y Terms of transaction y Past contacts, transactions, negotiations, and agreements y Purpose of the transaction and plans or proposals y Source and amount of funds or other consideration y Interest in securities of the subject company y Persons/assets retained, employed, compensated, or used y Financial statements o Prohibited practices  Trading with material nonpublic information regarding a tender offer  Rule 14d-10 no preferential pricing o Issuer Share Buybacks  Often use a modified Dutch auction o SEC Review of Issuer Distributed Materials  Going private SEC Rule 13e-3  Federal filings required in M&A y Schedule 13D must file Schedule TO as soon as practical on the commencement date y File Form 13D within 10 days of the transaction y Mini-Tenders no need to file if the tender is less than 5% y Schedule 8-K initial regulatory document filed in a friendly M&A transaction y Rule 145 applies to situations where securities are offered as a result of business combinations due to mergers, acquisitions, etc. o Securities are required to be registered, likely with Form S-4 y SEC Rule 165 written communications are permitted once there is a public announcement of a business combination y Form S-4 if securities will be offered in connection with a merger or acquisition, etc. y Rule 135 an issuer is permitted to publish a notice that contains only limited information o Names o Business description o Date and time o Brief transaction description y Regulation M-A facilitate communications and disclosures made by companies engaged in cash and stock tender offers, or mergers and acquisitions o Requires a summary term sheet be provided to investors as part of the disclosures made in a tender offer or merger Hart Scott-Rodino Act o Federal antitrust law  Thresholds: y Acquiring party will hold aggregate stock and assets valued at more than $65.2 million y Total transaction is valued at more than $260.7 million

OFFERING TYPES
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Types of issuer organizations o C-Corporations  Pay corporate taxes on income

Shareholders must pay personal taxes on profits received (double taxation) No limit on number of shareholders o S-Corporations  Taxed like a partnership (pass through to shareholders)  Limit of 100 shareholders  All shareholders must be U.S. citizens or resident aliens  Shareholders must be individuals, estates, or certain types of trusts  Must be domestic  Cannot be part of an affiliated group of corporations  Only one class of voting stock o Limited Liability Company  Pass through for taxes  Limited liability for owners  Does not continue to new owners oftentimes o Partnerships  Pass through for taxes  General partnerships have unlimited liability for each owner  May be dissolved at any time by any partner o Real Estate Investment Trust (REIT)  95% of gross income must be derived from real estate-related activities  Must be a trust  Must distribute a minimum of 90% of its income to shareholders  Must be at least 100 separate shareholders and 5 or fewer individuals may not own more than 50% of its common stock during the last half of its taxable year Types of Investors o Institutional investors  Bank  Savings and loan association  Insurance company  Investment adviser  Any other entity with total assets of at least $50 million  403(b) employee benefit plan  Member or an associated person of the member, or a person acting on behalf of an institutional investor  Qualified Institutional Investor  Insurance companies, registered investment companies, pension plans, corporations, and registered investment advisers  Buyer must be purchasing for its own account or the account of other QIBs  Buyer must own and invest at least $100 million of securities of issuers not affiliated with the buyer  Hedge Funds  Private Equity Firms Types of Financing Transactions o Public Offering o Private Placement o Private Investment in Public Equity (PIPE)  Stock price often declines when announced for 2 reasons:  Increase in shares that will become outstanding  Perception that the company is in need of capital and has limited means of raising it SEC Registration Forms o S-1: basic form that issuers may use, generally used by IPO candidates
 

S-3: used for shelf registrations (short form). Only available for issuers with $75 million in public float and not available for issuers that have failed to pay dividends on preferred stock, interest on a bond, or are delinquent on SEC filings o S-4: used for issues that are a result of M&A, consolidations, reclassifications of securities, or transfers of corporate assets o S-8: registering securities that are made available through employee benefit plans Registration Process: o Requirements for filing:  5 copies of preliminary prospectus, which must include  Character of issuers business  Balance sheet no older than 90 days prior to the filing  Income statements for the latest year and 2 preceding years  Amount of capitalization and use of proceeds  Monies paid to affiliated persons or businesses of the issuer  Shareholdings of senior officers, directors, and underwriters o Preregistration process  Preparing registration statement  Underwriters may not discuss the new issue with customers during this period  Underwriters perform due diligence o Waiting Period  SEC reviews the registration to determine that it is complete  Underwriters are permitted to:  Discuss the issue  Provide the red-herring (preliminary prospectus)  Record names of potential purchasers  Underwriters are not permitted to:  Sell the new issue  Accept payment for the new issue  Blue sky laws  Effective date 20 days after the last amendment filed in response to a deficiency letter o Posteffective Period  Marketing process  Price of the offering is set on the morning of the effective date  Final prospectus sent to potential purchasers  Stop Order:  If new, material information becomes available after the effective date, the SEC can require the prospectus to be amended and all sales orders be ceased until that prospectus is effective o Prospectus Delivery Requirement  Prospectuses must be delivered for 40 days after the effective date in the case of issuers with publicly traded securities already outstanding and 90 days for IPOs  Two exceptions  If an issuer was subject to the reporting requirements of the SEA of 1934 prior to the filing, there is no prospectus delivery requirement  If the issuer was not a reporting company prior to filing, but will be listed on an exchange or on NASDAQ as of the effective date, the requirement applies for 25 days
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Reporting Status at Time of Filing Nonreporting

Exchange or Nasdaq Listing Status Will be listed

After the Offering, Dealers Must Provide a Prospectus for 25 Days

Nonreporting Nonreporting Nonreporting

Will NOT be listed and is not an 40 Days IPO Will NOT be listed and is an IPO 90 Days Aftermarket prospectus requirements do not apply

Categories of Issuers:  SEC Rule 405 defines the different categories of issuers  Well-Known Seasoned Issuer (WKSI) required to file reports under Section 13(a) or Section 15(d) of the SEA of 1934 and meet the following:  Eligible to register on Form S-3 (short form of registration) or Form F-3 (registration statement for certain foreign private issuers)  Within 60 days of eligibility, must have:  Market cap greater than $700 million  Issued at least $1 billion total nonconvertible securities, other than common equity, in primary offerings for cash in the past 3 years  May not be an ineligible issuer  Shelf registrations are immediately effective with no SEC review  Majority-Owned Subsidiary of WKSI qualifies as WKSI if:  Securities are nonconvertible, other than common equity, and parent guarantees the securities fully and unconditionally  Securities are investment-grade  Securities are guarantees of nonconvertible securities  Seasoned Issuer  Eligible to use Form S-3 or F-3 to register a primary offering of securities  Unseasoned Issuer  Required to file reports under Section 13 or Section 15(d) but does not meet the requirements for Form S-3 or Form F-3  Nonreporting Issuer  Not required to file reports, even if the issuer files reports voluntarily  Ineligible Issuer  Issuers required to file reports that have failed to do so  Blank-check company  Shell company  Penny stock issuer  LP offering its membership units through methods other than a firm commitment underwriting  Issuer that has filed for bankruptcy or a filing was made against the issuer for insolvency in the past 3 years  Issuer convicted of a felony or misdemeanor that involves securities in the past 3 years  Issuer that has been the subject of a refusal or stop order o Shelf Registration: Governed by Rule 415; allows securities to be sold on a delayed or continuous basis  For securities sold in connection with a business combination, registration is allowed only for an amount that may reasonably be expected to be sold within 2 years after the initial date  Standard shelf registrations are valid for 3 years after initial effective date if:  An offering that will begin immediately and last for a period greater than 30 days from the effective date
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An offering that is for S-3 or F-3 registered, offered and sold on an immediate, continuous, or delayed basis o At-the-Market Offerings (ATM)  Securities are sold at the prevailing market price directly into the secondary market through a designated broker-dealer on a continuous basis  Only S-3 or F-3 eligible can use ATMs o Types of Offering Communications:  Written  Oral (includes recordings)  Research Reports  Advertising  Internal Syndicate Memoranda o Gun-Jumping Provisions: restrict the type of communications that may be made during a registered public offering  Rule 134: Communications not deemed a prospectus  Tombstone ads shown in the newspaper may include:  Name of the issuer  Full title of security  Amount of offering  Business description  Price of security  Date of sale  Underwriters  Statement of effectiveness  Contact information  Offering schedule  Exchanges  Selling security holders (if disclosed in prospectus)  Rule 135: Generic advertising  Advertisements describing, in general, how investment companies work  Gun-jumping safe harbors  Rule 168 allows the issuer to continue publishing or disseminating regularly released factual business and forward-looking information at any time o Electronic road shows:  Live real-time road shows are not written communications  Live road shows are oral communications  Recorded road shows are written communications  Road shows for follow-on offerings and nonconvertible debt offerings do not need to be filed with the SEC o Regulation S-K  Establishes guidelines for the format used for projections o Regulation S-X  Establishes format and content for financial statements  Pro forma  Schedules  Interim statements  Accountant reports  Consolidated and combined statements  ESOPs, etc. Research Reports: o Rule 137: Persons not participating in an offering


Broker dealers that are not involved in an offering can publish research reports for securities that are in the registration process  Broker dealer may distribute research reports for securities in registration when it does so on a regular basis o Rule 138: Nonequivalent securities  If a registration statement has been filed for a nonconvertible debt security or a nonconvertible preferred stock, a broker dealer may publish or distribute in the normal course of business reports regarding common stock and convertible securities of the issuer (EVEN IF BROKER DEALER IS IN THE DEAL) o Rule 139: Research Reports  Can publish reports on WKSIs whenever  Industry reports must contain substantial information regarding certain companies Communication-Related Liability o False Registration Statement: the parties that may be sued for untrue statements and material omissions:  Everyone who signed the registration statement  Every director or partner of issuer at time of filing  Every accountant, engineer, or appraiser named as having prepared or certified any part of the registration statement  Every underwriter o Salespersons liable for the investment amount, reasonable amount of interest, and amount of income received from the investment if they did not exercise reasonable care regarding the untrue statements Regulation FD Fair Disclosure o Bars issuers from selectively disclosing nonpublic, material information to securities professionals or to shareholders if it is reasonably foreseeable that they will trade on the information o If the disclosure was intentional, then the company must simultaneously disclose the information to the public o If the disclosure was unintentional, the company has 24 hours to publicly disclose the information Sarbanes-Oxley Act o Annual reports o Financial disclosure o CEO and CFO certifications of annual and quarterly reports o Loans to officers and directors o Disclosure of insider transactions o Code of ethics o Section 404 stress test on internal controls Exempt securities o Certain securities are exempt from the registration process, including:  U.S. government and government agency securities  Municipal securities  Nonprofit organizations  Short-term corporate debt (less than 270 days)  Domestic bank and trust companies (not bank holding companies)  Small business investment companies (SBIC) o Regulation A:  Exemption for small issues of securities  Company must be U.S. or Canada-based with 2 years of financial statements  Maximum amount is $5 million within a 12 month period and no more than $1.5 million can be sold by current shareholders


Issuers may not make a written or oral offer unless a Form 1-A has been filed with the SEC  Preliminary or final offering circular must be distributed to prospective buyers at least 48 hours prior to mailing confirmation of the sale  Issuers are allowed to test the waters regarding investment interest prior to filing an offering statement with the SEC o Exempt Transactions  Private Placements  Placement Agent  Placement Agent Agreement  Engagement Letter  Teaser  Term Sheet  Confidentiality Agreement  Subscription Agreement  Section 4(2) exemptions: exempts from registration transactions by an issuer that does not involve a public offering  Section 4(6) exemptions: exempt if:  Total amount is less than $5 million  No advertising or public solicitation may be used  Only sold to accredited investors (includes institutional investors)  Regulation D  Also allows 35 nonaccredited investors to participate  Form D must be filed with the SEC no later than 15 days after the first sale of securities  Rule 504: covers offerings less than $1 million within a 12 month period  Unlimited number of investors without regard to experience or sophistication  Three types of issuers are not eligible:  SEC Reporting companies  Investment companies  Development stage companies with no business plan  Rule 505: covers offerings less than $5 million within a 12 month period  Unlimited number of accredited investors  Financial institutions  Director, executive officer, or GP of the issuer  Individuals that have net worth > $1 million or gross income for each of last 2 years of at least $200k ($300k with spouse)  Rule 506: covers offerings of unlimited amounts  Nonaccredited investors must be restricted to those who, either alone or with their purchaser representative, have the knowledge and experience in financial and business matters to be able to evaluate the merits and risks of the investment  Restricted securities:  Securities under Regulation D are cannot be sold until they become registered, or they are sold under a registration exemption  144A: permits the sale of restricted stock to qualified institutional buyers without the conditions imposed by Rule 144  Ineligible securities  Securities that are the same class as those listed on an exchange or quoted on Nasdaq


Securities issued by registered investment companies  Qualified Institutional Buyers (QIB)  Insurance companies  Registered investment companies  Small BDCs  Private and public pension plans  Certain bank trust funds  Corporation, partnerships, business trusts, and certain nonprofits  Registered investment advisers  *Must be purchasing for its own account or the account of other QIBs  *Must own and invest at least $100 million or securities of issuers not affiliated with the buyer Rule 144  Holding period  With restricted stock, the purchaser must hold the stock for six months before selling it (begins when the securities were bought by the original purchaser and must have been fully paid for at time of purchase)  Six month period applies to:  Individuals purchasing stock  Individuals given the stock  Securities acquired by a trust from a beneficiary who was the original purchaser  Securities acquired by a pledge from a pledgor who was the original purchaser  No holding period for estates of a deceased person  No holding period for control stock  Holding period applies for restricted stock  Exception = person who has not been an affiliate of the company for at least three months prior to the sale and has owned the stock for at least one year prior to the sale


TYPES OF SECURITIES
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Preferred vs. common stock preference over common: o Regarding payment of dividends o In the event the company has to liquidate its assets Stockholders have the right to: o Freely transfer shares o Inspect certain books and records of the company Dividends: o Declaration Date = date that the dividend is authorized o Record Date = date on which the shareholder must officially own the stock to be entitled to receive the dividend o Ex-Dividend Date = Time between record date and date that the dividend is paid when the stock trades without the dividend Voting o Only common stockholders have voting rights o Statutory voting = shareholders vote each of their shares once for each director slot being contested

Cumulative voting = shareholders may multiply the number of shares they own by the number of directors being elected and cast all the votes in any way they want Preferred Stock o Always carries a specified dividend
o o o

o o o

Only represents the maximum amount, if the company is not performing they may choose not to pay out preferred dividends Cumulative vs. Non-cumulative:  With cumulative preferred, if the dividend is suspended for a period of time, the preferred shareholders must receive payment for the dividends deferred in years past before the common shareholders get anything  Ex: If over the last 3 years preferred shareholders specified dividend amount is $5 per year but they only received $2 per year, they must receive $11 before the common shareholders receive anything ($6 for years past and $5 for current year)  In non-cumulative preferred, dividends in arrears are not paid to stockholders Participating Preferred: in addition to the specified dividend rate, if common dividends reach a specified level, the preferred owners get additional dividends Callable Preferred: the company has the right to repurchase (call) the stock at a specified price some time in the future. Usually the call price is higher than par value. Convertible Preferred: Ability to exchange shares for common stock at a specified price at the shareholders discretion  Determine the conversion ratio by dividing the par value by the conversion price  Ex. Par value = $100, conversion price = $25  Conversion ratio = 4-to-1 and the preferred shareholder would receive four shares of common stock for each share of preferred  Appeals to investors who want higher, more secure income than common stocks, but also want the higher potential for capital appreciation

Characteristic Ownership in the company More likely to receive regular dividends Higher priority if the company goes bankrupt Greater potential for capital appreciation Voting rights Issued with a specific dividend rate
y y

Common Preferred P P P P

P P P

oDividend Yield = Annualized dividend / current stock price Rights and Warrants: o Preemptive right if the corporation issues new stock, current shareholders have the right to buy before the shares are offered to the public o Rights Offering Process of offering preemptive rights to common shareholders o Subscription Price Purchase price for a rights offering, which is well below the current market value of the stock o Warrants  Similar to stock options, but unlike options, warrants do not expire for a number of years after issuance (some are perpetual).

Subscription price is usually higher than the current market price of the stock when it is first issued.  Can usually be detached and sold separately from the underlying security o Stock Appreciation Rights Issued by a company and provide employees (not investors) with the right to receive the difference between the current market value and a fixed price American Depositary Receipts or Shares o Used to facilitate trading of foreign stocks in the United States o ADR represents a claim to foreign securities, with the shares themselves being held by U.S. banks abroad o Sponsored ADR Company pays a depositary bank to issue shares in the U.S. Issue will be on NYSE or Nasdaq. o Unsponsored ADR Company does not pay for the cost associated with trading in the U.S. Issue will be in the OTC market. Fixed Income Securities (Bonds) o Par Value Principal or face value o Prices - $1,000 face value = 100% = 100  Each 1% increment is known as a point o Maturity Date Day on which the issuer mush pay the principal of the bond to the investor o Coupon Rate Stated amount of interest that the issuer agrees to pay. Typically bonds pay interest semiannually. o Zero-Coupon Bonds  Do not pay interest at regular intervals  Typically bought at a deep discount  Yields are usually slightly higher but prices tend to be more volatile o Calculating returns: There are 4 ways to calculate returns on fixed income securities:  Nominal yield stated, fixed coupon  Current yield Annual interest payment divided by current market price  Yield to maturity Most widely used. Includes yearly interest as well as the difference between what the investor paid for the bond and the amount received at maturity.  Yield to call Takes into account a bonds cash flow through its first call date. It is calculated the same way as yield to maturity, except that it reflects the bonds interest payments until it is called, rather than when it matures o Call Provisions  Refunding When the issuer has the option to retire a more expensive bond and refinance with a lower interest rate bond  Call Risk Risk that bondholders take that the issuer will call the bond in a falling interest rate environment  Call Protection Restriction on how soon the call feature can be exercised, typically 5-10 years from the date of issue  Call Premium Issuer will usually need to pay investors more than the par value of the bonds in order to compensate them for the call risk o Sinking Funds Funds that issuers set up to accumulate money to redeem their bonds o Put Provisions Gives the bondholder the right to redeem the bond on a specified date or dates prior to maturity, usually receiving par value. o Yields on callable bonds would be higher than the same bonds that are not callable, to give investors an incentive to purchase callable debt o Yields on bonds with put features are typically lower, given the ability of bondholders to redeem their bonds and reinvest the principal should interest rates rise. o Prices and Yields: An Inverse Relationship: As interest rates rise, the value of existing bonds will decline since the demand for existing bonds that now offer lower interest rates will decline, driving down their prices. If interest rates decline, the value of existing bonds will increase since


o o

they are worth more than a new bond with a lower coupon. Therefore, yield and price movements have an inverse relationship. Relationship of prices and various yield measurements  Discount bond: Nominal yield < Current yield < Yield to maturity  Premium bond: Nominal yield > Current yield > Yield to maturity  Prices of long-term bonds tend to fluctuate more than those with shorter maturities  Bonds selling at a discount fluctuate more than bonds selling at a premium  Short-term bonds yields fluctuate more than those for long-term bonds. Duration or Modified Duration:  Duration is a measure, expressed in years, of a fixed-income securitys price sensitivity to increases or declines in interest rates.  Duration measures the % change in the market value of a bond, given a small change in interest rates  Duration allows the comparison of interest-rate risk among securities with different coupons, maturities, and credit quality Convexity  The relationship between yield and price is not linear  Positive convexity describes the condition where, as yields decline, prices increase at a faster rate for long-term bonds as compared to intermediate or short-term bonds. In other words, durations lengthen when rates fall and durations shorten as rates rise  Negative convexity occurs in mortgage-backed securities where duration shortens when rates fall and lengthens when rates rise Trust Indenture Act of 1939 A corporation issuing more than $10 million of debt must provide an indenture between the issuer and a trustee who will act on behalf of the bondholders. Types of Bonds:  Secured Bonds  Mortgage collateral = real estate  Equipment trust collateral = equipment  Collateral trust collateral = stocks or bonds

Liquidation Rights:  1st = Bondholders  Secured Unsecured Subordinate  2nd = Preferred stockholders  3rd = Common stockholders o Convertible Bonds:  Conversion price is set at the time the bond is issued  Number of shares to be received is calculated with conversion ratio  Par Value of Bond ($1,000) divided by Conversion Price  Conversion price and ratio are adjusted for stock splits and stock dividends  Advantages:  Allow corporations to borrow at a lower rate because convertible feature is attractive to investors  Give investors a greater degree of safety than preferred or common stock but give them the potential for capital appreciation if the underlying stock appreciates in value  Investor has downside protection  Disadvantages  Significantly dilutes current shareholders if all the bonds are converted into stock
o

Forced conversion: when the investor is essentially forced to convert if the bonds are called by the issuer at a disadvantageous point in time o Other types of bonds  Income bonds Issuer promises to pay principal at maturity, but only promises to pay interest if it has sufficient interest  Eurodollar Bond Dollar-denominated deposit outside the U.S. Pay principal and interest in U.S. dollars and are issued outside the U.S.  Yankee Bond Allow foreign entities to borrow money in the U.S. marketplace  Eurobond Sold in one country and denominated in the currency of another Treasury Securities o Savings bonds = non-negotiable because they cant be sold in the secondary market (only redeemable by the U.S. government) o Marketable (negotiable) securities:  Treasury bonds  Treasury notes  Treasury bills  STRIPS  TIPS  CMBs o Prices quoted in 1/32nds of par, while prices of most other bonds are quoted in increments of 1/8th o Treasury Inflation-Protected Securities (TIPS) Based on the CPI; rate of interest is fixed, however the principal amount on which the interest is paid may vary o T-Bills Short-term securities that mature in one year or less o Cash Management Bills (CMB) Unscheduled short-term debt offerings used to even out Treasury cash flows. Duration can be as short as one day. o Treasury STRIPS Dealers may purchase T-notes and T-bonds and separately resell the coupon and principal payments as zero-coupons after requesting this treatment through a federal reserve bank.  Sold at a discount o Agency Securities  Federal Home Loan Banks (FHLB)  Federal Home Loan Mortgage Corporation (FHLMC Freddie Mac)  Federal National Mortgage Association (FNMA or Fannie Mae)  Government National Mortgage Association (GNMA or Ginnie Mae) Derivatives o Examples:  Forward contracts  Futures contracts  Options  Structured products  Collateralized mortgage obligations (CMOs) o Options:  Put vs. call  Listed vs. OTC  Listed are traded on CBOE, AMEX, PHLX, or PSE  Listed options are cleared through the Options Clearing Corporation (OCC)  OTC are not cleared and have the risk that the counterparty may default on its obligation  Components:  Underlying security  Expiration month


Exercise price  American vs. European  American option contract may be exercised anytime up to the day before expiration  European option can be exercised only during a specific period, though it is usually the day before expiration  Premium market price of an option at a particular time (amount paid by the buyer to the seller for the rights conveyed by the contract)  Buying calls:  Allows investors to employ leverage to get control of the stock for a smaller amount of money than if they bought the stock outright  Potential profit is theoretically unlimited  Risk is limited to the premium plus commission costs  Selling calls:  Writing covered calls:  Allows investors to increase the return on their portfolios and to partially insulate their stocks against falling prices  Ex: an investor owns 100 shares of XYZ, for which they paid $100 per share, or a total of $10,000. The investor writes a call against this stock with a strike price of $110 and a premium of $5.  If the price of the stock remains the same, the investor has earned an additional $500 on this position ($5 x 100)  If the stock declines, the premium from the covered call reduces the investors losses. Assume XYZ drops to $90 and the call is not exercised. The stock is now worth $1,000 less than the investor paid for it, but the $500 premium reduces total losses from $1,000 down to $500  If the stock rises and the call is exercised, the investor still retains the premium plus whatever they make from selling the stock at its strike price  Writing uncovered calls:  Among the riskiest of option strategies  If the call is exercised, the writer will have to buy the stock in the open market in order to deliver it to the call owner  Since there is no upward limit on how high the stock may rise, the investors potential loss is unlimited  Unsuitable for most investors  Buying puts:  For an investor who is bearish on a particular stock  Selling puts  If the stock rises, the investor gets to keep the premium  If the stock falls, the investor will need to buy the stock for more than its worth  Maximum potential loss is the exercise price of the contract minus whatever premium received for selling the put o Futures  Obligates the buyer to purchase the underlying commodity and the seller to sell it, unless the contract is offset before settlement date  Forwards were the precursors of futures  Now used for currency transactions  Non-transferable  Futures can be readily bought and sold on the exchange on which they trade


Must have 2 characteristics (1) supply and demand for the underlying commodity or financial instrument must be large, (2) different units of the underlying item must be fungible (easily interchanged) o Structured Products  Prepackaged securities that often combine securities, such as a bond with a derivative  May be linked to any of the following underlying assets:  Stock index  Foreign currency  Interest rate and inflation linked product  Commodity  Basket of securities  Change in spread between asset classes  Single security


UNDERWRITING
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Underwriting Commitments o Sale of a public offering is typically conducted through a group of broker-dealers, known as the underwriting syndicate o Firm Commitment: if the syndicate agrees to purchase the entire issue and absorb any securities that are not sold o Best Efforts: If the underwriters agree to place as much of the new offering as they can, returning the unsold securities to the issuer o All-or-None: Corporation might require a specific minimum of capital  Escrow Account: deal may be canceled if not enough is sold, so funds are held in an escrow account until the offering is complete o Standby Agreement: Used in rights offerings. Syndicate agrees (in return for a fee) to purchase any unsubscribed shares from the rights offering Distribution of Securities o Syndicate: lead by one of the underwriters (managing underwriter)  Other broker dealers will be invited to participate in the distributions  Syndicate members sign an underwriters agreement that specifies rights and obligations o Selling group:  Sometimes the syndicate will recruit other broker-dealers to assist in the sale of the offering (known as the selling group)  Do not assume any financial liability in the offering, acting instead as placement agents o Syndicate process:  Underwriters assess demand and determine public offering price  May not sell at a lower price  Underwriting spread:  Syndicates gross profit  Underwriters give selling group members a portion of the spread (not in addition)  See page 8-5 for additional details o Green Shoe: allows the underwriters to purchase up to 15% more shares than were originally slated for the offering o Market-Out Clause: allows the syndicate to cancel its commitment, if certain events occur that make marketing the issue difficult, or impossible Industry Regulations Concerning Marketing Restrictions: o ATM Offerings o State or Blue Sky Laws o FINRA Suitability Rules

Retail clients Institutional clients o Research-related rules  Solicitation of investment banking business research analysts are prohibited from participating in the solicitation of investment banking services  Road shows research analysts are prohibited from participating in a road show if their firm is connected with an investment banking service transaction  Communication with customers research analysts are allowed to discuss the issue with clients once their firm has the mandate for the transaction and it has been publicly announced  Investment banking department  Investment bankers are prohibited from directing a research analyst to participate in the sales and marketing efforts for an investment banking service transaction  Promise of favorable research a research analyst may not accept compensation from an issuer to prepare a favorable research report  Restrictions on issuing reports  For IPOs, analysts cant issue reports for 40 calendar days following the offering  For Secondaries, analysts cant issue reports for 10 calendar days following the offering  Does not apply for securities that are actively traded as defined under Regulation M (average daily trading volume of at least $1 million and public float of $150 million)  Restrictions on public appearances:  Research analysts are not permitted to make a public appearance regarding the issuer during the quiet period  Conference call  Seminar  Media interview  Articles  Exception = significant news  Termination of research coverage  Firm must publish a final report if it decides to terminate coverage FINRA Rules on Securities Distribution o Corporate Financing Rules  Filing requirements:  If securities are registered, broker dealers must file documentation no later than 1 business day after filing the issuers registration statement.  If securities are unregistered, disclosures must be filed at least 15 days prior to the anticipated offering  Documents to be filed  Copies of registration statement, offering memo, offering circular  Copies of any underwriting agreements, letters of intent, escrow agreement  Copies of pre-and-post amendments to the registration statement  Copies of the final registration declared effective  Information to be filed:  Estimate of maximum offering price  Estimate of maximum underwriting discount, or commission, underwriters counsel fees, maximum finders fees, and statement of any other type of compensation  Statement concerning the affiliation with any member firm of an officer or director of the issuer, or a beneficial owner of 5% or more of the issuers securities
 

Detailed statement explaining any other arrangement entered into during the 180 day period prior to the filing date  Statement demonstrating compliance with any exception from the definition of underwriting compensation Regulation M: restricts distribution participants and issuers from bidding for or purchasing in the secondary market stock that is being offered in a distribution for a certain period revolving around the effective date o Rule 101 Activities of Distribution Participants  Prevent those interested in a distribution from manipulating secondary market trading for their own benefit  These parties are not permitted to buy or bid for the subject security within a critical time frame called the restricted period  Restricted Period  ADTV < $100k and Public Float < $25 million = 5 days  ADTV > $100k and Public Float > $25 million = 1 day  Also applies to reference securities (ex: underlying common stock in a convertible bond deal)  Exceptions:  Government and muni bonds  ADTV > $1 million and Public Float > $150 million  Odd-lot transactions  Exercising options  Unsolicited brokerage transactions and purchases  Selling to QIBs  Transactions in the subject security that are part of a basket strategy (cant be more than 5% of the basket) o Rule 102 Activities of Issuers  Prohibits issuers and selling security holders (insiders) from supporting or raising the prices of a security being distributed  May not purchase or bid for a covered security, or induce others to do so  Exceptions:  Unsolicited purchases  144A  Exercise of convertible securities  Odd-lot  Exempted securities  101 Exemptions not available:  Actively traded securities of the issuer or affiliate  Basket transactions  Inadvertent transactions o Rule 102 Passive Market Making  Permits distribution participants to continue making markets in a Nasdaq stock on a passive basis  The market maker may not enter a bid or effect a purchase at a price that exceeds the highest independent bid on Nasdaq  Limit on quantity purchased = greater of 30% of ADTV, or 200 shares  Falling market  In a falling market, when the last independent bid drops below that of a passive market maker, the passive market maker may maintain its bid until its purchases have reached or exceeded the lesser of two times the minimum quote size, or the passive market makers remaining daily limit o Rule 104 Stabilization


Placing a bid, or effecting a purchase, for the purpose of pegging, fixing, or otherwise maintaining the price of a security  This is permitted by an underwriter o Rule 105 Short Sales in Connection with an Offering  It is a violation for any person to sell short the security that is the subject of an offering then purchase the offered security from an underwriter  If the short was executed during the 5 bus. days prior to pricing  Exception:  If the person was not aware of the offering and changed their mind, closing out the short at least one business day prior to the pricing Record Keeping o Syndicates must maintain the following information  Percentage participation or commitment for each member  Names and addresses of the member of the syndicate  Dates when the penalty bid was in effect  Name and class of any security stabilized or any security in which a syndicate short covering transaction was effected  Price, date, and time at which each stabilizing purchase or syndicate short was effected o General records:  All records must be kept for the first two years in an easily accessible place  Requires broker dealers obtain the following information from associated persons:  Name, address, SSN, starting date  DOB  Business background for 10 years  Disciplinary action for securities  Felony indictments  Aliases Listing Requirements o NYSE  400 U.S. shareholders  1,100,000 shares outstanding  Market cap of $140 million  Stock price of $4 at time of listing  At least one of several alternative financial tests o Nasdaq  Different requirements for Global Select, Global Market, and Capital Market  Only 3 must be satisfied under all three standards:  $4 minimum bid price  3 or 4 market makers  Subject to corporate governance  Other requirements:  Pretax earnings  Cash flow  Market cap  Revenue  Global Select = Most stringent


Capital Market = Least stringent

VALUATION

Relative Valuation o Price to Earnings (P/E) indication of how the market capitalizes a companys earnings or what the market is willing to pay for each dollar of earnings o Earnings Yield = EPS / Price per Share (reciprocal of P/E ratio)  Use this when earnings are negative o P/E to Growth Ratio  P/E/Growth rate (not percentage, so 10% growth would use 10, not 0.10)  PEG ratio greater than 1.0 could indicate an overvalued stock and vice versa for PEG ratios less than 1.0  Use forward looking or trailing information  Not relevant for companies with negative earnings o Be prepared to calculate all three ratios using various input data o Compound Annual Growth Rate = CAGR  (Ending Value/Beginning Value) ^ (1/n) 1  Wont have the capabilities to do this so will have to just simply average growth rates to approximate CAGR o Price to Free Cash Flow o Price to Sales  Used for start-up industries that do not have significant earnings yet o Price to Book o Enterprise Value  Equity Value = Market Price x Shares Outstanding  Plus Long-Term Debt  Less Cash and Equivalents Discounted Cash Flow o Values a company on the present value of the expected cash flows o Need to have  Estimated discount rate (WACC)  Estimate of cash flows for given period  Estimate of terminal value  Multiple method  Perpetuity Growth method  = CF(n+1) / (WACC g) o Dividend Growth Model  Cost of equity created by retained earnings  K = (Dt/P0) + G  K = Required Rate of Return  Dt = Dividend to be paid at the end of the year  P0 = Current market price  G = Growth rate per year o Free Cash Flow to the Firm  EBIT x (1 t)  + Depreciation and Amortization  - Capex  +/- Change in Working Capital o Free Cash Flow to Equity  Net Income  + Depreciation and Amortization  - Capex  +/- Changes in Working Capital o Dividend Discount Model  Assumes investors buy stock solely for dividends and desire a current return

P0 = (d1/(1+k))+ (d2/(1+k)2) + (dn/(1+k)n) Constant Growth Case = k = (d+g)/P0  P0 = D1/(k-g)  Known as Gordon Growth Model Economic Profit differs from accounting profit as it takes into consideration the cost of capital (profit above the expected returns on capex) o Looking at unit costs for manufacturing businesses o Return on equity o Marginal revenue vs. marginal cost analysis Sum of the Parts Analysis o If the company were sold today, would the individual business segments sell for more than the total corporate entity? Valuation Multiples o Multiples of Earnings  P/E  EV / EBITDA or EV / EBIT  Cash earnings multiples o Multiples of Book Value  P / BV or P / TBV  EV / BV o Multiples of Revenue  P / Sales  EV / Sales
 

Sector Cyclical High Tech, High Growth High Tech, No Earnings Heavy Infrastructure REITs Financial Services Retailing Retailing
y

Multiple Used Relative P/E PEG Price/Sales or EV/Sales EV/EBITDA

Rationale Use when normalized earnings When there are big differences across firms Assume future margins will be good

Firms in sector have losses in early years and reported earnings can vary depending on depreciation method Price/Cash Flow or Generally no capex; investments come from equity FFO earnings Price/BV, EV/BV, Book value often marked to market P/TBV Price / Sales If leverage is the same across firms EV / Sales If leverage is different across firms

Other methodologies to be familiar with o Comparable Transactions o Comparable Companies o Leveraged Buyout Effects of exchange rate risk: o Strong U.S. dollar: make foreign companies more attractive takeover targets for U.S. based buyers; U.S. companies will be less attractive for foreign buyers o Weak U.S. dollar: Opposite