Amanda has an arrangement with her broker to receive 3,200 shares of all available IPOs. The average IPO offer price is $15. When the IPO is very successful, which is 15% of the time, the average closing price at the end of the first day of trading is $25. When the IPO is successful, which is 75% of the time, the average closing price at the end of the first day of trading is $18 and when the IPO is unsuccessful, which is 10% of the time, the average closing price at the end of the first day of trading is $10.

1. Calculate underpricing when the IPO is very successful, successful, and unsuccessful. What is the average IPO underpricing?
2. Suppose the shares are rationed 30 to 1 when very successful, 10 to 1 when successful, and 1 to 1 when unsuccessful. What is Amanda’s expected one-day dollar return on her investments?
3. Given the return in (b) above, what is your view on whether Amanda will continue to invest in future IPOs and why?

Answer rating: 100% (QA)

Underpricing Calculation Very Successful Underpricing Closing Price Offer Price 25 15 10 Successful ... View the full answer