A company goes public with an offering price of $18. There is a 7 percent underw

Question

A company goes public with an offering price of $18. There is a 7 percent underwriting spread. There is also a 15 percent overallotment option. The company is selling 25 mil-lion shares. The underwriter fills orders for 28.75 million shares but has not exercised the overallotment option. The stock rises to $20. How much would it cost the underwriter to cover the short position? If the underwriter used all its profits from the short position to purchase shares, how many shares would it purchase (include the shares that must be purchased to cover the short position)?

Explanation / Answer

Additional no. of shares = 3.75 million (28.75- 25).

Stock rise to $20.

By using Overallotment option, he can buy 15% of 25 million = 3.75 million at offering price of $18.

Hence, for each stock he made 2$ profit. (20-18).

So total profit is, 3.75 million * 2 = $ 7.5 Million.

The additional shares, he need to buy at market price of $20.

7.5 Million/20= 375,000 shares.

Total No. of shares he purchase = 3.75 million + 375,000 = 4.125 million shares (including 3.75 million shares that need to purchased to cover the short position).

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