How Securities Firms Facilitate the Flow of Funds

Recall that Carson Company has periodically borrowed funds but contemplates a stock or bond offering so that it can expand by acquiring some other businesses. It has contacted Kelly Investment Company, a securities firm.

a. Explain how Kelly Investment Company can serve Carson and how it will serve other clients as well when it serves Carson. Also explain how Carson Company can serve Kelly Investment Company.

b. In a securities offering, Kelly Investment Company would like to do a good job for its clients, which include both the issuer and institutional investors. Explain Kellys dilemma.

c. The issuing firm in an IPO hopes that there will be strong demand for its shares at the offer price, which will ensure that it receives a reasonable amount of proceeds from its offering. In some previous IPOs, the share price by the end of the first day was more than 80 percent above the offer price at the beginning of the day. This reflects a very strong demand relative to the price at the end of the day. In fact, it probably suggests that the IPO was fully subscribed at the offer price and that some institutional investors who purchased the stock at the offer price flipped their shares near the end of the first day to individual investors who were willing to pay the market price. Do you think that the issuing firm would be pleased that its stock price increased by more than 80 percent on the first day? Explain. Who really benefits from the increase in price on the first day?

d. Continuing the previous question, assume that the stock price drifts back down to near the original offer price over the next three weeks (even though the general stock market conditions were stable over this period) and then moves in tandem with the market over the next several years. Based on this information, do you think the offer price was appropriate? If so, how can you explain the unusually high one-day return on the stock? Who benefited from this stock price behavior, and who was adversely affected?