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The owner of Gator Airlines wishes to take her firm public by selling 4 million shares. The underwriter determines that the true value will be $12 with probability .3 and $8 with probability .7. There are a group of uninformed investors who are willing to buy 4 million shares as long as they expect not to lose money on average. They also assess the probability of the true value of the shares being $12 with probability .3 and $8 with probability .7. There is a group of informed investors who always know whether the true value is $12 or $8. They are willing to order 2 million shares if the offer price is less than the true value. Assume that if more shares are ordered than are available for sale, the underwriter allocates the available shares on a pro-rata basis based on the size of each groups order (i.e., the fraction of shares a group gets is equal to the groups order/total shares ordered).

(a) [5 points] Calculate the highest offer price at which the entire issue will surely sell.

(b) [5 points] If the stock is sold at the offer price you calculated in (a), could an uniformed investor make money on average by submitting an order to buy some shares of the new issue? Why or why not?

(c) [5 points] If the stock is sold at the offer price you calculated in (a), what will be the expected stock return on its first day of trading?

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Beverley Smith
Beverley SmithLv2
31 Mar 2018

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Alex Dale is a portfolio manager at ADIA Investment Company inEurope. Alex would like to buy 50,000 shares of alpha stock whichis a new IPO that was previously offered at £30, but unfortunatelyhe couldn’t get any shares of it. Now, he is still interested inthese shares, but not at a price that is greater than £45. JillJones works for The Global Brokerage House, which providesexecution services for ADIA. In his conversation with Alex, Jillhas suggested that a market order is most suitable for the trade.Alex is also interested in using a market order to sell a largeblock of Gamma shares. However, he is worried that if he instructeda selling using a market order the price would decline and he loseson the value of the deal. Jill argued that this should not be aproblem as automated order driven trading systems provide specialarrangements for small trades (which are often market orders) aswell as for block trades. Alex is also interested in reducing thecost of selling of his Christian Dior shares, Jill suggested thathe should use European electronic crossing network to sell some ofhis shares. She told Alex that these networks are cheap, preserveanonymity and allows for 6 crossing opportunities of trades perday. They also allow participants to place some restrictions suchas price and minimum fill. All orders submitted to the network isgood for day which is means that any unfulfilled part of an orderis automatically resubmitted to subsequent crossing sessions duringthe day. Following Jill’s advice, Alex has submitted his 150,000 CDshares to be sold in the European crossing network with a minimumfill of 125,000. The following orders are on the network for theshares of CD at the time of the first crossing session of the day.The most recent trading price of CD at the Paris Bourse is € 37. A order: a market order to buy 100,000 shares  B order: a marketorder to sell 50,000 shares  C: an order to buy 20,000 shares at €36 In the next crossing session new orders are submitted. The mostrecent trading price of CD at the Paris Bourse is € 38.  D order:a market order to buy 150,000 shares  E order: A market order tosell 50,000 In her speech to buy side clients Jill has made thefollowing statements about electronic communication and crossingnetworks (ECNs): Statement 1: Electronic communication networks areorder driven systems, in which the limit order book plays the acentral role Statement 2: Electronic crossing networks anonymouslymatch buy and sell orders by a pool of participants, generallyinstitutional investors and broker dealers Statement 3: In an ECN,a trade takes place only during a crossing session time and only ifthere are offsetting orders entered by other participants.

Task: 1. For buying alpha shares, should Alex place a marketorder or a limit order? What would be the advantage anddisadvantage of each type of order, given his purpose? (2 Marks) 2.In selling a large block of Gamma shares explain Jill’s argumentthat automated order driven trading systems must provide specialarrangements for small and large trades? (1 Mark) 3. In the firstcrossing session discuss what trades would take place on thecrossing network and what orders remain unfilled? (2 Marks) 4. Inthe second crossing session discuss what trades would take place onthe crossing network and what orders remain unfilled? (2 Marks) 5.Which of Jill’s statement about electronic communication andcrossing networks (ECNs) is true? Justify your answers. (1 Mark) 6.Indicate how you would assess the quality of financial markets? (2Marks)

Scandal Inc., plans to issue $5 million of bonds with a coupon rate of 8 percent and 15 years to maturity. The current market interest rates on these bonds are 7 percent. In one year, the interest rate on the bonds will be either 12 percent or 4 percent with equal probability. Assume investors are risk-neutral.

a. If the bonds are noncallable, what is the price of the bonds today? Assume a par value of $1,000 and semiannual payments. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Price of Bonds: $________

b. If the bonds are callable one year from today at $1,050, will their price be greater or less than the price you computed in part a?

QUESTION 10

Short-term bond yields are generally ______ than long-term bond yields, whereas long-term bond prices are generally ________ than short-term bond prices.

more volatile, less volatile

less volatile, more volatile

less volatile, less volatile

more volatile, more volatile

2.5 points

QUESTION 11

Common stockholders have a residual claim to income, in other words they are last in line.

True

False

2.5 points

QUESTION 12

Stock classes are similar to bond ratings in that they are used to rank the performance of different corporations' stock.

True

False

2.5 points

QUESTION 13

The particular type of shareholder voting used has become less important with the influence of takeovers, leveraged buy-outs, and other challenges to management control.

True

False

2.5 points

QUESTION 14

Which of the following is not a true statement?

Common stockholders have a residual claim to income.

Bondholders may force a corporation into bankruptcy for failure to make interest payments.

Common stockholders are legally entitled to some dividend.

A minority interest can still elect members to the Board of Directors under cumulative voting even though someone else owns 51% of the stock.

2.5 points

QUESTION 15

The purpose of cumulative voting is

to maintain majority control of the board of directors.

to allow minority stockholders the possibility of a voice on the board of directors.

to obstruct unfriendly mergers and takeover efforts.

to prevent the dilution of common stock through preemptive rights offerings.

2.5 points

QUESTION 16

A rights offer made to existing shareholders with the sole purpose of making it more difficult for another firm to acquire the company is called

a preemptive right.

a poison pill.

ex-rights.

rights-on.

2.5 points

QUESTION 17

A possible advantage to a rights offering is that

current shareholders are protected against dilution.

the firm has a built-in market of knowledgeable investors.

distribution costs are lower than a public offering.

All of these options

2.5 points

QUESTION 18

Which of the following actions will provide the shareholders with the most total wealth when a company conducts a rights offering?

Exercise the rights for new shares.

Sell the rights themselves and hold existing shares and cash.

Exercise the rights and sell the shares.

None of these options

2.5 points

QUESTION 19

The subscription rate of a new offering is generally _______ than the rights-on price and _______ than the ex-rights price.

higher; higher

higher; lower

lower; higher

lower; lower

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