Question

Define underpricing, and explain why the majority of IPOs are underpriced. What role do investment banks play in the price-setting process?

Answer 1

Ans ) Underpricing is the practice of listing an initial public offering (IPO) at a price below its real value in the stock market. When a new stock closes its first day of trading above the set IPO price, the stock is considered to have been underpriced.

reason of underpriced IPO

IPO may be underpriced deliberately in order to boost demand and encourage investors to take a risk on a new company. ... In any case, the IPO is considered underpriced by the difference between its first-day closing price and its set IPO price.

role of investment bank in price settings process

One of the primary roles of an investment bank is to serve as a sort of intermediary between corporations and investors through initial public offerings (IPOs). Investment banks provide underwriting services for new stock issues when a company decides to go public and seeks equity funding.

Part of the investment bank's job is to evaluate the company and determine a reasonable price at which to offer stock shares. IPOs, especially for larger companies, commonly involve more than one investment bank. This way, the risk of underwriting spreads across several banks, reducing the exposure of any single bank and requiring a relatively lower financial commitment to the IPO. Investment banks also act as underwriters for corporate bond issues.