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 priceYou 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 BB) Contract CC) You are indifferentD) Contract A

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
check_circleExpert Solution
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:

IPO Price Value of Firm x (1+Standard Deviation)
-S70 Millx (1+0.40)
S70 Millx1.40
= $98 Mill
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IPO Price Value of Firm x (1+Standard Deviation) -S70 Millx (1+0.40) S70 Millx1.40 = $98 Mill

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Step 2

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

IPO Price Value of Firm x (1- Standard Deviation
= $70 Mill x (1-0.40)
= $70 Mill x 0.6
= $42 Mill
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IPO Price Value of Firm x (1- Standard Deviation = $70 Mill x (1-0.40) = $70 Mill x 0.6 = $42 Mill

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Step 3

Contract A:

Price = $20 Mill

Green provision = 15%

IPO price of the Firm T = $70 Mill

 

C...

Total Value of Contract A = Price+(Green Provision x IPO price of the Firm T
$20 Mill(15%x $70 Mill)
= $20 Mill 10.5 Mill
- $30.5 Mill
help_outline

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Total Value of Contract A = Price+(Green Provision x IPO price of the Firm T $20 Mill(15%x $70 Mill) = $20 Mill 10.5 Mill - $30.5 Mill

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