The Bert Corp. and Ernie, Inc., have both announced IPOs. You place anorder for 1,100 shares of each IPO. One of the IPOs is underpriced by $17.75 and the other is overpriced by $6.25. You will receive all of the shares you ordered of the overpriced IPO, but only one-half of the shares you ordered of the underpriced IPO. What profit do you expect?

Question

Leonel Manning

Business

1 June, 21:24

The Bert Corp. and Ernie, Inc., have both announced IPOs. You place anorder for 1,100 shares of each IPO. One of the IPOs is underpriced by $17.75 and the other is overpriced by $6.25. You will receive all of the shares you ordered of the overpriced IPO, but only one-half of the shares you ordered of the underpriced IPO. What profit do you expect?

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Chana · Answer 1

The profit expected from the two IPOs is $2887.5

Explanation:

For the overpriced IPO, 1100 shares would be received and since the share was overpriced by $6.25, an instant loss of $6,875 ($6.25*1100) is recorded.

For the under-priced IPO, 550 shares (1100 shares divided by 2) would be received and the immediate gain recorded is $9,762.5 (550 * $17.75)

Overall the two portfolios, when taken together, give an immediate gain of $2,887.50 (gain of $9,762.50 less loss of $6,875)

This is power of portfolio diversification, that managing potential investment losses by spreading one's investment.