Principles of Managerial Finance

CHAPTER 7 Stock Valuation 319

FIGURE 7.2

The Selling Process for
a Large Security Issue
The investment banker hired
by the issuing corporation
may form an underwriting
syndicate. The underwriting
syndicate buys the entire
security issue from the issu-
ing corporation at an agreed-
on price. The underwriter
then has the opportunity (and
bears the risk) of reselling the
issue to the public at a profit.
Both the originating invest-
ment banker and the other
syndicate members put
together a selling group to
sell the issue on a commis-
sion basis to investors.

Investment

Banker

Investment

Banker

Investment

Banker

Issuing

Corporation

Underwriting Syndicate

Selling Group

Originating

Investment

Banker

Purchasers of Securities

Investment

Banker

large number of brokerage firms. Each member of the selling group accepts the

responsibility for selling a certain portion of the issue and is paid a commission

on the securities it sells. The selling process for a large security issue is depicted in

Figure 7.2.

Compensation for underwriting and selling services typically comes in the

form of a discount on the sale price of the securities. For example, an investment

banker may pay the issuing firm $24 per share for stock that will be sold for $26

per share. The investment banker may then sell the shares to members of the sell-

ing group for $25.25 per share. In this case, the original investment banker earns

$1.25 per share ($25.25 sale price$24 purchase price). The members of the

selling group earn 75 cents for each share they sell ($26 sale price$25.25 pur-

chase price). Although some primary security offerings are directly placed by the

issuer, the majority of new issues are sold through public offering via the mecha-

nism just described.

Interpreting Stock Quotations

The financial manager needs to stay abreast of the market values of the firm’s out-

standing stock, whether it is traded on an organized exchange, over the counter,

or in international markets. Similarly, existing and prospective stockholders need

to monitor the prices of the securities they own because these prices represent the

current value of their investments. Pricequotations,which include current price

data along with statistics on recent price behavior, are readily available for

actively traded stocks. The most up-to-date “quotes” can be obtained electroni-

cally, via a personal computer. Price information is available from stockbrokers

and is widely published in news media. Popular sources of daily security price