Question

Asked Nov 8, 2019

You work for Goldman Sachs who is the lead underwriter of Firm T's IPO. You need to set up the contract and Firm T has agreed to any of the two following contracts:

Contract A: $20 mill and a green provision of 15% (which matures in 1 day)

Contract B: $21mill

Contract C: $19mill +1% of the IPO price

You have estimated the price of Firm T to be 70mill and this is the IPO price. The daily volatility on the IPO day is around 40%. The risk-free rate is 0%. Use Black-Scholes to choose one contract.

Answer choices:

A) Contract B

B) Contract C

C) You are indifferent

D) Contract A

Step 1

Value of the Firm T= $70 Mill

Volatility or Standard Deviation = 40% or 0.40

Value of the Firm T= $70 Mill

Volatility or Standard Deviation = 40% or 0.40

Calculation of the IPO price of Firm T in UP situation is as follows:

Calculation of the IPO price of Firm T in UP situation is as follows:

Step 2

Calculation of the IPO price of Firm T in DOWN situation is as follows:

Step 3

**Contract A:**

Price = $20 Mill

Green provision = 15%

IPO price of the Firm T = $70 Mill

C...

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