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Investment banker acting as an "underwriter"

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1. When an investment banker acts as an "underwriter" he (Points: 3)
gives a "firm commitment" to purchase the securities from the corporation at a set price.
the company suffers a decline in earnings after taxes.
may sell as many securities as possible and return the rest unsold.
may give advice to management.

2. Dilution of earnings occurs because (Points: 3)
a new issue of common stock creates more shares outstanding which reduces earnings per share temporarily.
the company suffers a decline in earnings after taxes.
the investment banker collects an underwriting fee.
all of the above.

3. A firm has $1,000,000 in its common stock account and $2,500,000 in its paid-in capital account. The firm issued 100,000 shares of common stock. What was the original issue price if only one stock issue has ever been sold? (Points: 3)
$35 per share
$25 per share
$10 per share
Not enough information to tell

4. The ______________ method of inventory costing is least likely to lead to inflation-induced profits. (Points: 3)
Weighted average
Lower of cost or market

5. Total asset turnover indicates the firm's (Points: 3)
debt position.
ability to use its assets to generate sales.

6. Which of the following is a potential problem of utilizing ratio analysis? (Points: 3)
trends and industry averages are historical in nature.
financial data may be distorted due to price-level changes.
firms within an industry may not use similar accounting methods.
all of the above

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1. When an investment banker acts as an "underwriter" he (Points: 3)
gives a "firm commitment" to purchase the securities from the corporation at a set price.

2. Dilution of earnings occurs because (Points: 3)
a new issue of ...

Solution Summary

The solution examines an investment banker acting as an underwriter.

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Insider trading

Generally defined, insider trading is the buying or selling of a company's securities, by corporate officials or others with a fiduciary duty, on the basis of nonpublic information that's supposed to remain confidential. As noted in McLean (see the attached material, page 266) such inside trading is illegal under U.S. securities law. Non-insiders aware of a fiduciary breach can also be held liable. A recent example in healthcare is the case of Senate Majority Leader Bill Frist. Mr Frist was under investigation by the U.S. Attorney's office for possibly having engaged in insider trading. According to the U.S. Attorney's office, Frist "...sold all his stock in his family's hospital corporation about two weeks before it issued a disappointing earnings report and the price fell nearly 15 percent."

Avoiding such problems with the insider trading laws may be more complex than you think. Consider the following short case for question 2 of 2:

Dr. Brown is a well known professor of Oncology. He is the principal investigator in a phase III study of a new drug being developed by Company X, a publicly listed pharmaceutical company. This new drug could have blockbuster potential when it is registered for sale. Dr. Brown has been invited to speak about new scientific trends at the next World Oncology Congress; a part of his presentation will cover the study on this new drug. With its promising results and excellent therapeutic and safety profile, Company X, which is sponsoring the study, has already approved Dr. Brown's presentation and is preparing a press release on the preliminary results of the phase III study to be delivered on the first day of the Congress. Well in advance of the Congress, the Scientific Committee and the responsible Professional Congress Organizer (PCO) have requested scientific abstracts of all proposed presentations. Is there anything which should concern Dr. Brown if he submits his abstract - as requested - before the Congress starts?

Answer: Yes, because Dr. Brown is considered to be an "external insider" under EC Directive 2003/6/EC of January 28, 2003. This Directive and a similar ruling by the Security Exchange Commission in the US ("Selective Disclosure and Insider Trading", release 33-7881), - collectively known as "Insider Trading Rules" - exist to ensure that price sensitive data, which could influence the stock price of a publicly listed company, is not released in a selective way, and to punish any subsequent insider trading of such stocks. Therefore, the transfer of sensitive data to the Scientific Committee and the PCO is a problem for all of them (including Dr. Brown) if it is done before the data is issued to the public. Dr. Brown is an independent physician and is not employed by Company X, but he is still considered to be an "external insider" under the "Insider Trading Rules outlined above because he is in possession of data which could influence the stock price of Company X.

Questions (the first is primarily based on the attached material)

1. What are some implications on the prohibition of trading on the basis of inside information? Is that prohibition, on balance, worth retaining? (use the attached material)

2. What should Dr Brown (and others in similar situations) do to avoid charges of insider trading?

Again, Please, do not exceed 100-150 words per answer.

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