Question

The Woods Co. and the Mickelson Co. have both announced IPOs at $56 per share. One of these is undervalued by $8, and the other is overvalued by $2, but you have no way of knowing which is which. You plan to buy 1,200 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled.
If you could get 1,200 shares in Woods and 1,200 shares in Mickelson, what would your profit be?

Profit

___________________$

What profit do you actually expect?

Expected profit____________________

$

Answer 1

Answer:

* If you could get 1,200 shares in Woods and 1,200 shares in Mickelson, your profit would be: $7,200;

* Actual expected profit: $2,400.

Explanation:

* If you could get 1,200 shares in Woods and 1,200 shares in Mickelson, what would your profit be?

The total profit would be equals to the sum of positive payoff and negative payoff in which:

Positive payoff = Undervalued per share * 1,2000 shares bought = 8 * 1,200 = $9,600.

Negative payoff = Overvalued per share * 1,2000 shares bought = (2) * 1,200 = $(2,400)

=> Total profit = $9,600 - $2,400 = $7,200.

*  What profit do you actually expect:

As for positive payoff stock purchasing, we can only get half of the stock which is 600 stocks, the profit will be again equals to the sum of positive payoff and negative payoff in which:

Positive payoff = Undervalued per share * 600 shares bought = 8 * 600 = $4,800.

Negative payoff = Overvalued per share * 1,2000 shares bought = (2) * 1,200 = $(2,400)

=> Total profit = $4,800 - $2,400 = $2,400.