You’re considering buying shares in a small Canadian mining company that has just issued an initial public offering (IPO) of shares on the Vancouver Stock Exchange at $8 per share. A limited number of “early” investors were able to purchase these shares at $8 on the IPO date, but you weren’t able to get any shares at that price. Instead, you plan to buy on the open market the day after the IPO. After an IPO, two things may happen: (i) The underwriters may purchase shares if they think the price is dropping too low, and (ii) the “early” investors who bought shares the day before at the IPO price may sell. You ask the advice of a stockbroker about the likelihood of each of these. “Looking at data from similar recent IPOs, the probabilities of those things happening are 0.27 and 0.34, respectively,” he replies.
a) Which method of probability assessment did the stockbroker use?
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b) Do you think the underwriters purchasing and the “early” investors selling are independent events?
c) What’s the minimum probability that the underwriters will purchase and the “early” investors will sell?