Business, Legal & Accounting Glossary
When an IPO (initial public offering) is offered at a price which is under its market value it is known as underpricing. Normally underpricing of a stock is a temporary affair since market forces of supply and demand eventually drive stocks to their intrinsic value.
IPO underpricing is done mostly due to liquidity and uncertainty concerns regarding the level of stock trading. Stocks which have low predictability and low liquidity have a higher degree of underpricing. This is done to compensate investors who are undertaking a greater level of risk. The issuer of an IPO knows much more about a share’s value compared to its investor. Companies deliberately underprice stocks for encouraging greater investor participation in IPO. Underpricing of IPOs often brings substantial financial gains for investors. IPO issuers engage in what is known as leaving money on the table.
Initial Public Offering refers to a company’s first sale of shares to the public. IPOs are offered in the primary market (distinct from the secondary market). When a company’s management declares that it wants to make that company public it implies that an IPO is on offer. A successful IPO offering can garner a large volume of capital for the company concerned. A public offering is done through a process called underwriting. Underwriter guarantees a definite price for a stated number of securities to issuer of a security. For this service, underwriters charge a fee. Underwriter thus bears the risk of an issue.
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This glossary post was last updated: 2nd April, 2020 | 0 Views.