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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 700,000 shares to be issued is very strong. His broker’s firm is assigned 25,000 shares in the distribution and will allow Michaels, a relatively good customer, 1.3 percent of its 25,000 share allocation. The initial offering price is \(30 per share. There is a strong aftermarket, and the stock goes to \)32 one week after issue. The first full month after issue, Mr. Michaels is pleased to observe his shares are selling for \(33.50. He is content to place his shares in a lockbox and eventually use their anticipated increased value to help send his son to college many years in the future. However, one year after the distribution, he looks up the shares in The Wall Street Journal and finds they are trading at \)28.50.

c. Why might a new public issue be expected to have a strong aftermarket?

Step by step solution

01

Meaning of issue of shares

The company provides new shares to the shareholders and this process is called the issue of shares. The shares are issued in the primary market by the company. These shares can be allocated through public or private placement of shares.

02

Explanation regarding the reason new issues have a strong aftermarket

The investment banks often offer a new public issue at underpriced rates due to which it is believed that once the issue is allotted to the public, the value of the shares will increase and result in a strong aftermarket for the shares.

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