Airdnd, a startup specialized in a new generation of air filters, considers entering the IPO market.The underwriter knows that an average investor of the IPO market will commit to purchasing
2000 shares of the IPO stocks (subject to rationing). Furthermore, the underwriter's analyst teamestimates that with 75% probability the market condition will be favorable, and Airdnd's stocks
will be traded at $50 on the first day. In that case, Airdnd's initial offerings will be oversubscribed20-to-1, meaning that investors get 1 share for every 20 shares they committed to buying.Otherwise, Airdnd's stocks will be traded at $30, and all orders of the investors will be filled. LetP denote Airdnd's IPO price.


(a) If the underwriter sets P = 40, what is the expected first-day profit of an average investorparticipating in Airdnd's IPO, taking into account the share rationing?

(b) What is Pmax, the maximum IPO price P that the underwriter can set for Airdnd's stock?Keep 2 digits after the decimal point.

(Hint: the maximum P is the one such that the expected profit of an average investor is exactlyzero. You can solve Pmax by replacing 40 with Pmax above and setting the equation to zero. If
your answer to part a above is positive, then Pmax will be larger than 40. Otherwise, Pmax shouldbe lower than 40)

(c) Use the answer you found in part (b), calculate the average first-day return of Airdnd withouttaking into account share rationing. Is Airdnd underpriced? By how much?

Answer rating: 100% (QA)

To solve this problem we need to calculate the expected firstday profit of an average investor participating in Airdnds IPO for different IPO prices P ... View the full answer