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.

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.

Step by step solution

01

Information provided in the question

Share to be allotted = 25,000 shares

Initial offer price = $30 per share

Stock price after one week = $32 per share

Percentage provided by the broker = 1.3%

02

Calculation of profit/loss after one week

The profit after one week is $650.

$$\begin{gathered} \mathrm{Profit}/\mathrm{Loss}=\mathrm{Percentage}\mathrm{provided}\mathrm{by}\mathrm{broker}\times \mathrm{Number}\mathrm{of}\mathrm{shares}\mathrm{allocated}\times \left(\mathrm{Current}\mathrm{price}-\mathrm{Initital}\mathrm{price}\right) \\ =1.3\%\times 25,000\left(\$32-\$30\right) \\ =650 \end{gathered}$$

03

Calculation of profit/loss after one month

The profit after one month is $1,137.50.

$$\begin{gathered} \mathrm{Profit}/\mathrm{Loss}=\mathrm{Percentage}\mathrm{provided}\mathrm{by}\mathrm{broker}\times \mathrm{Number}\mathrm{of}\mathrm{shares}\mathrm{allocated}\times \left(\mathrm{Current}\mathrm{price}-\mathrm{Initial}\mathrm{price}\right) \\ =1.3\%\times 25,000\left(\$33.50-\$30\right) \\ =\$1,137.50 \end{gathered}$$

04

Calculation of profit/loss after one year

The loss after one year is $487.50.

$$\begin{gathered} \mathrm{Profit}/\mathrm{Loss}=\mathrm{Percentage}\mathrm{provided}\mathrm{by}\mathrm{broker}\times \mathrm{Number}\mathrm{of}\mathrm{shares}\mathrm{allocated}\times \left(\mathrm{Current}\mathrm{price}-\mathrm{Initial}\mathrm{price}\right) \\ =1.3\%\times 25,000\times \left(\$28.50-\$30\right) \\ =-487.50 \end{gathered}$$

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