Initial public offerings (IPO’s) have a reputation for being underpriced. Thus, if you can obtain shares of an underpriced IPO, you might make a large profit on the first day of trading. In contrast to underpriced IPO’s, there are overpriced IPO’s. An overpriced IPO is one in which the price typically declines on the first day of trading. Thus, obtaining shares of an overpriced IPO may result in negative returns on the first trading day. You decide to start an investment fund that will invest in all new IPO’s. You call your new fund the “Superior Performance IPO Fund.” Assume that the average underpriced IPO makes a 30% return in one day and the probability of obtaining shares in the average underpriced IPO is Pu. Assume that the average overpriced IPO makes a -10% return in one day and the probability of obtaining shares in the average overpriced IPO is Po It is four times more likely to obtain shares of an overpriced IPO than an underpriced IPO, and there is a 50 percent chance of not obtaining any shares (in which case you invest in a t-bill with an expected effective annual return of 6 percent). 

2A) (6 points) Find Po and Pu 

2B) (2 point) State what the probability is of investing in a t-bill. 

2C) (6 points) Find the daily return to the T-bill, assuming 365 days in a year.

 2D) (5 points) Using the probabilities and daily returns of underpriced IPO’s, overpriced IPO’s, and T-bills, what is the expected daily return of the Superior Performance IPO fund? 

2E) (5 points) What is the Effective annual return of the Superior Performance IPO fund?

Answer rating: 100% (QA)

2A We know that the probability of obtaining shares in an overpriced IPO is four times higher than t... View the full answer