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Capital Mobilization and Capital Asset Pricing Model - Term Paper Example

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The author of the paper explains how large companies raise capital from the equity and bond markets. The author of the paper also discusses the relevance of the capital asset pricing model ( CAPM) to the company seeking to evaluate its cost of capital…
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Capital Mobilization and Capital Asset Pricing Model
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Download file to see previous pages Stage 1 decisions determine the direction of fundraising, which gets ratified and implemented in stage 2.  The firm has to decide whether to raise funds through common stock, preferred stock, bonds or hybrid securities or a combination. In the case of common stock, the firm has to decide whether it should be a rights issue or public issue.

The company can put on offer its block of securities for sale to the highest bidder or negotiate a deal with the investment banker. Since in the latter, the investment bankers should carry out a substantial investigation, they would do it for best-known companies. Otherwise, the prohibitive costs and uncertainty of clinching the deal would make the bidding for lesser-known companies unattractive for the investment bankers. Therefore, only the very large companies, about 100 of the largest companies in the New York stock exchange have a choice of seeking competitive bidding for their offering. Others have only an option of a negotiated deal with an investment banker.

In case of a negotiated deal, the firm has to select an investment banker. Most of the investment banks operate in niches. For instance, older and larger veteran merchant bankers such as Morgan Stanley deal mainly with IBM, AT&T and Exxon and such and Drexel Burnham Lambert deals with speculative issues. Some investment bankers have a penchant for new issues, while some others with a conservative brokerage client base would not take up speculative and risky issues.

In Stage 2, the firm’s initial decisions will be revisited by the merchant banker. For instance, the merchant banker, after studying the environmental trends, may recommend and convince the management to change their earlier plan of raising $200 million by selling common stock to raising $100 million by common stock and the rest by the issue of bonds.
In this stage, the firm and investment banker will come to a conclusion as to whether the banker will work on the best efforts basis or will underwrite the issue. ...Download file to see next pagesRead More
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