You have an arrangement with your broker to request 1,025 shares of all available IPOs. Suppose that 11% of the time, the IPO is "very successful" and appreciates by 114% on the first day, 78% of the time it is"successful" and appreciates by 10%, and 11% of the time it "fails" and falls by 13%.
a. By what amount does the average IPO appreciate the first day; that is, what is the average IPO underpricing?
b. Suppose you expect to receive 70 shares when the IPO is very successful, 200 shares when it is successful, and 1,025 shares when it fails. Assume the average IPO price is $19. What is your expected one-day return on your IPO investments?