The Woods Co. and the Garcia Co. have both announced IPOs at $40 per share. One

Question

The Woods Co. and the Garcia Co. have both announced IPOs at $40 per share. One of these is undervalued by $9, and the other is overvalued by $4, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled.

If you could get 1,000 shares in Woods and 1,000 shares in Garcia, what would your profit be? (Do not round intermediate calculations.)

What profit do you actually expect? (Do not round intermediate calculations.)

The Woods Co. and the Garcia Co. have both announced IPOs at $40 per share. One of these is undervalued by $9, and the other is overvalued by $4, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled.

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

Undervaluation would increase profit and overvaluation would result in a loss.

Amount of Profit = 1000*9 (Value of Overvalued Shares) - 1000*4 (Value of Undervalued Shares) = $5000

Part B:

Since only half of the order will be fulfilled for underpriced shares, we will get 500 shares for the underpriced security.

Profit Actually Expected = 500*9 - 1000*4 = $500

Thanks.

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