The risk-averse founder of a successful private company wants to sell the company publicly by offering 100,000,000 initial shares. The initial market share price at the IPO is uncertain: it will equal either 99 USD or 101 USD, but each of these potential initial market share prices has equal probability. Two investment banks offer to underwrite the IPO. Investment bank A offers to underwrite the IPO at best effort for a fixed fee of 1,000,000 USD; the fee would be deducted from the founder's proceeds from the sale of shares at the uncertain initial market share price. Investment bank B offers a firm commitment to underwrite at fixed price of 99.99 USD per share, with no fee. In either offer, the founder will sell all 100,000,000 shares. 

(a) Compute the expected profit of each investment bank, if chosen by the founder. Which investment bank, if chosen, would have higher expected profit? 

(b) Compute the variance of profit for each investment bank, if chosen by the founder. Which investment bank, if chosen, would have higher variance of profit?  

(c) Comment on the trade-off between risk and return for offers to underwrite at best effort and at fixed price. Please limit your comment to one sentence. 

Answer rating: 100% (QA)

Investment Bank A The fee for Investment Bank A is fixed at 1000000 which will be deducted from the founders proceeds Expected proceeds with an initia... View the full answer