Question 7: (Total 11 marks) The Mars Co. and the Mercury Co. have both announce

Question

Question 7: (Total 11 marks) The Mars Co. and the Mercury Co. have both announced IPOs at $30 each. One of them is under-priced by $8 and the other is over-priced by $3. However, you don't know which is under-priced and which is over- priced so you plan to bid for 1,000 shares of each IPO. Required: (a) What would be your profit if you could get 1,000 shares in both IPOs? (b) If an issue is under-priced, the offer will be rationed and only half of your order will be filled. What will be (3 marks) 4 marks) 4 marks) your profit in this case? (c) If the market is strong-form efficient, what will you do? What will be your profit?

Explanation / Answer

a) We get 1000 shares in each of IPO. We will gain $8,000 in one of IPO and loose $3,000 in another as one is underpriced $8 and it would increase by $8 and another is overpriced $3 and it would decrease by $3.

So net profit is $8000-$3000 = $5000

b) So in this case, we will only get 500 shares for the issue which is underpriced.

So profit from the issue which is underpriced will be 500*8 = $4000 and loss from oversubsribed will be -$3000

So net profit is $4000-$3000 = $1000

c) If market is strong form efficient then it means even insider cannot profit acting with any unknown information.

In strong form effiecient , we will get underpriced issue in the proportion that the net profit will be zero.

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