IPO Underpricing The Woods Co. and the Garcia Co. have both announced IPOs at $4

Question

IPO Underpricing The Woods Co. and the Garcia Co. have both announced IPOs at $40 per share. One of these is undervalued by $11, and the other is overvalued by $3, 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? What profit do you actually expect? What principle have you illustrated?

Explanation / Answer

If you could get 1,000 shares in Woods and 1,000 shares in Garcia, what would your profit be?

If you receive 1,000 shares of each, the profit is:

Profit = 1,000($11) – 1,000($3)

Profit = $8,000

What profit do you actually expect?

Since you will only receive one-half of the shares of the oversubscribed issue, your profit will be:

Expected profit = 500($11) – 1,000($3)

Expected profit = $2500

What principle have you illustrated?

This is an example of the winner’s curse

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.