Question: I. B. Michaels has a chance to participate in a new public offering by Hi-Tech Micro Computers. His broker informs him that demand for the 500,000 shares to be issued is very strong. His broker's firm is assigned 15,000 shares in the distribution and will allow Michaels, a relatively good customer, 1.5 percent of its 15,000 share allocation. The initial offering price is $30 per share. There is a strong aftermarket, and the stock goes to $33 one week after issue. The first full month after issue, Mr. Michaels is pleased to observe his shares are selling for $34.75. He is content to place his shares in a lockbox and eventually use their anticipated increased value to help send his son to college many years in the future. However, one year after the distribution, he looks up the shares in The Wall Street Journal and finds they are trading at $28.75.
a. Compute the total dollar profit or loss on Mr. Michaels's shares one week, one month, and one year after the purchase. In each case compute the profit or loss against the initial purchase price.
b. Also compute this percentage gain or loss from the initial $30 price and compare this to the results that might be expected in an investment of this nature based on prior research. Assume the overall stock market was basically unchanged during the period of observation.
c. Why might a new public issue be expected to have a strong aftermarket?