Describe underwriter profits from the overallotment option

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Question: Problem 1: A company is going public at $16 and will use the ticker XYZ. The underwriters will charge a 7 percent spread. The company is issuing 20 million shares, and insiders will continue to hold an additional 40 million shares that will not be part of the IPO. The company will also pay $1 million of audit fees, $2 million of legal fees, and $500,000 of printing fees. The stock closes the first day at $19.

The company in Problem 1 grants a 15 percent overallotment option to the underwriter. The underwriter issues shares that are backed by the entire overallotment option but has not yet exercised the option.

a. Explain what will happen if the price of the stock increases to $22. Describe the underwriter profits from the overallotment option in your explanation.

b. Explain what will happen if the price of the stock decreases to $11.50. Describe the underwriter profits from the overallotment option in your explanation.

Reference no: EM132213367

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