Question: Question 1: IPO (5 points) IPO underpricing is a common phenomenon in many financial markets in the world. a. Please explain what is IPO underpricing

Question 1: IPO (5 points) IPO underpricing is a common phenomenon in many financial markets in the world. a. Please explain what is IPO underpricing (i.e., definition) (1 point). b. Please explain in detail why underpricing could happen for IPOs in general. Provide detailed numerical illustrations based on the returns realized by following two investors who participate in IPO allocation. Assume there are three firms and two investors in the IPO market. Three identical firms announced IPOs, and each firm offers 20 shares at an offer price of $5/share. Firm X is undervalued by $2 per share. Firm Y is overvalued by $2 per share. Firm Z is overvalued by $1 per share. One investor (i.e., Smart investor) is informed but the other investor (i.e., Average investor) is uninformed about the true value of these three firms. Both investors have an initial wealth of $120. IPO shares are allocated in pro-rata basis in the case of oversubscription. Assume that investors capital is logged upon their applications for IPO share allocation (4 points).

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