FIN 7810 Homework 2

Qiguang Wang

1. DoorDash went public in 2019. Its IPO fillings include the following forms:

• S-1: Registration statement under Securities Act of 1933

• S-1/A: Amendment to S-1
• 424B4: Prospectus in accordance with Rule 424(b)(4) of the Securities Exchange
Act of 1933

S-1 is also called red herring prospectus, which is the firm’s initial registration with
SEC. S-1/A include changes and updates made to S-1, such as shares offered, price
bands, and new underwriters. 424B4 is the final prospectus, which includes information
such as final offering price and number of shares, use of the proceeds, and allotment of
shares. You can access these forms through SEC Edgar Archive.
Companies with revenue of $1 billion or less were qualified to file IPO registration
statement confidentially. However, following SEC’s announcement on Draft Registra-
tion Statement1 in June 29, 2017, all companies can file confidentially, effective July
10, 2017. Read these two articles2 3 for further explanation.

• Does DoorDash take advantage of this rule change by filling confidentially? If so,
when does DoorDash file for IPO with SEC for the first time?
Solution: Yes. It filed Draft Registration Statement on 2020-02-03.

• When does the filling become public?

Solution: It became public on 2020-11-13 when Uber first filed for S-1.

• Who were the underwriters? Who was the lead underwriter?

Solution: There are 12 underwriters in total. Goldman Sachs & Co. LLC and
J.P. Morgan Securities LLC are the representatives of the underwriters.

• What were the price bands set by the underwriter? If more than one set of price
bands, show them all.
Solution: $75–$85 on Nov 30, 2020;
$90–$95 on Dec 4, 2020;

1
https://bit.ly/2tJbteJ
2
https://bit.ly/2lKJvwt
3
https://bit.ly/2kbvveJ

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 • How many shares were finally offered? And at what price?
Solution: 33 Million shares are offered at $102.

• Who received these shares? List the top 5 allotments and the names of recipients.
Solution: The Underwriters Table in page 286 of 424B4 filling lists all the share
allotments to underwriters, in descending order of the number of shares allotted.
Since underwriters are not required to disclose how they distribute their share
allotments to their clients, we are not able to find which investors actually received
these shares.

2. Recent IPO trends and alternative listing method

(a) List the top 5 IPOs in 2020 by U.S. companies in terms of external capital raised.
[Hint: include only the new shares offered and ignoring all underwriting expenses]
Solution:
SnowFlake: 28M×$120 = 3.36B, 1st-Day: (253.930/120) -1 = 111.61%.
AirBnB: 50M×$68 = 3.4B, 1st-Day: (144.70/68)-1 = 112.79%
DoorDash: 33M×$102 = 3.366B, 1st-Day: (189.51/102) -1 = 85.8%
Rocket: 100M×$18 = 1.8B, 1st-Day: (21.51/18)-1 = 19.5%.
Unity Software: 25M×$52 = 1.3B, 1st-Day: (68.350/52) - 1 = 31.44%

(b) The IPO first-day return, also called IPO pop, is defined as the percentage return
of the closing market price of the first-day trading relative to the IPO offer price.
Calculate the first-day return for each deal.
Solution: See above.

(c) Which type of investors will benefit most from a large IPO pop? And which type
of investors suffer the largest losses?
Solution:
Most: Short-term primary market investors who receive the share allotment but
sell them on the first day.
Worst: Selling (existing) stockholders who sold their shares at a large discount
at IPO offering price. Had they not offered their shares in the primary market
and waited until the first public trading day, they would have sold their shares at
much higher price.

(d) Does a large IPO pop impose a cost to the issuing company? [Hint: opportunity
cost]
Solution:
Yes. A large IPO first-day return represents the opportunity cost of not being
able to sell their shares directly to the public investors at a much higher price and
raising much more external capital.

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 (e) If there is a large IPO pop, how would you rate the underwriters’ job?
Solution:
Poor. The IPO offering price was set too low to the market consensus. The
investment banks underwriting the deal give too much reward to primary market
investors, who are mostly their clients, at the expense of the issuing company.

(f) Average IPO first-day return fluctuates by time. How does 2021’s average IPO
first-day return compare to other years? [Hint: use Jay Ritter’s IPO data]
Solution:
2021 is among the highest year. The only other two years comparable to 1999 and
2000, the internet bubble. More details at https://site.warrington.ufl.edu/ritter/files/IPOs-
Underpricing.pdf

(g) If 2020’s average IPO first-day return is abnormally high or low compared to
history, can you offer some possible explanations?
Solution:
Open question. Possible explanation are investor sentiment, accumulation of free
money.

(h) Do you think that the IPO with its current underwriting process are getting more
and more costly to the issuing firm?
Solution:
This appears to be the case.

(i) Are there any cheaper alternatives to go public?

Solution:
Direct listing allows the firm to be listed their existing shares on the stock ex-
change without the underwriting process. On Dec 22, 2020, SEC issue an ap-
proval order (https://www.sec.gov/rules/other/2020/34-90768.pdf) which allows
the firms to list new shares and raise external capital directly.

3. The following is a list of current asked prices of Stock LUCKY:

price $15 $16 $17 $18 $20

shares 100 50 100 100 1000

(a) If you want to buy 500 shares, and you want to make sure that there are 500
shares in your account by the end of today. How do you make the order? What
will be the final cost of buying these stocks?
Solution: Market order. Final cost = $15 × 100 + $16 × 50 + $17 × 100 + $18 ×
100 + $20 × (500 − 350) = $8, 800

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 (b) Suppose you think the fair price is $10, so you don’t want to buy the stock at
a price higher than $10.5. How should you make the order? Will your order be
surely filled?
Solution: Buy Limit order at $10.5. The order will be executed at $ 10.5 or a
better price. Limit order guarantee the price but not the execution, hence, the
order will not be filled with certainty.

(c) You want to buy 100 shares. But you don’t have time to look at the price all
the time. Then you think the worst price you can accept is $25. How should you
make the order? If the price does increase to $25, what will be your buying price?
Solution: Buy stop order at $25. You are busy, so you cant monitor the price
all the time. So you decide to look at the price tomorrow afternoon. you are still
worried that the price could increase. Then you want to ”stop loss. You set a
stop order with the stop price $25. If the price increases to $25 before tomorrow
afternoon, you don’t lose a lot. If the price does not increase to $25 by tomorrow
afternoon, you can cancel it and make another order.
Alternative interpretation: Stop buy order can be used to enter trades when
a certain price level is reached. For instance, LUCKY stock price reaching an
analyst forecast or some technical indicator, signals to the investor that this stock
has some potential higher gains. The investor, then, wants to profit from that
possibility and enters a stop buy order which converts to market order when the
price of $25 is reached. That market order is then filled at the best ask or higher
price. As a reminder4 ,
i. A BUY STOP can only be placed ABOVE current market price.
ii. A BUY LIMIT can only be placed BELOW current market price.
And,
i. A SELL STOP can only be placed BELOW current market price.
ii. A SELL LIMIT can only be placed ABOVE current market price.

4. Miss Good wants to buy BAD stock, which is selling for $5 per share. She can buy on
margin. The initial margin requirement is 40%, and the maintenance margin is 30%.
There is 10% interest and service charge (paid in cash when purchasing).

(a) Miss Good has $2, 000 in hand. If she decides NOT to buy on margin; that is,
she wants to buy using only her own funds. Then what is the total shares she can
buy? If the price increases to $6 per share, what’s the rate of return? If the price
decreases to $4 per share, what’s the rate of return?
4
http://www.trade2win.com/boards/trading-faqs/31046-whats-difference-between-stop-loss-limit-
orders.html

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 Solution: So, initial price is P = 5 and amount of funds is F = $2, 000. The
total amount of shares she can buy
F $2, 000
= = 400
p $5

For the return, we use the formula from Lecture 1. The return is calculated as
the ratio of change in the investment value to the initial investment. For the price
= $6, we have,
value of stock − initial investment
=
initial investment
$2, 400 − $2, 000
= = 20%
$2, 000

For the price = $4, we have,

value of stock − initial investment
=
initial investment
$1, 600 − $2, 000
= = −20%.
$2, 000

(b) If Miss Good decides to buy on margin, and she wants to buy 500 shares. Then
how much she needs to deposit to her margin account?
Solution: Using the formula from Lecture 1

equity in account = margin × value of stock = 40% ∗ 500 ∗ $5 = $1, 000

(c) Miss Good buys 500 shares, and the funds in her margin account just meets the
initial margin requirement. The price decreases to $4. What’s the rate of return?
Will she receive a margin call?
Solution: The price drop from $5 to $4 represents a return of -20%. For Ms.
Good’s leveraged position, the rate of return will depend on the initial margin
requirement and the service charge.
value of stock − principal and interest
return =
Initial Investments
$2, 000 − $1, 000 − $1, 500 ∗ (1 + 10%)
=
$1, 000
= −65% < −20%.

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 which is lower than the return on the stock. For the margin we have,
equity in account
margin =
value of stock
$2, 000 − $(2, 500 − 1, 000)
= =
$2, 000
= 25% < 30% (maintenance margin).

So Ms. Good will receive a margin call.

(d) If the price decreases to $3. Will Miss Good receive a margin call? If she does
receive a margin call, but she does nothing (because she is traveling to the Dark
Side of the Moon). Then how many shares should the broker sell to keep the
margin above the maintenance margin?
Solution: The price drop from $5 to $3 represents a stock return of -40%. For
Ms. Good’s leveraged position, the rate of return will depend on the initial margin
requirement and the service charge (as before).

value of stock − principal and interest

return =
Initial Investments
$1, 500 − $1, 000 − $1, 500 ∗ (1 + 10%)
=
$1, 000
= −115% < −40%.

which is lower than the return on the stock. For the margin we have,
equity in account
margin =
value of stock
$1, 500 − $1, 500
= =
$1, 500
= 0 < 30% (maintenance margin).

The margin is way below the maintenance margin, so Ms. Good will receive a
margin call and the broker should sell all the 500 shares.

5. Mr. Handsome is interested in the UGLY stock. He finds that the price should be $3,
but the market price is $5 per share now. Mr. Handsome has $2, 000 in his margin
account. The initial margin requirement is 40%, and the maintenance margin is 30%.
Assume there are no interests and service charges.

(a) Mr. Handsome decides to short sell the UGLY stock, but he does not have more
money to deposit to his margin account. Then, how many shares can he short?
Solution:

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 For the shares shorted we have,
deposited funds
shares short =
price × (required margin)
$2, 000
= = 1000
$5 ∗ 40%

(b) Mr. Handsome is very confident in his prediction. So he wants to short as many
as possible. But unfortunately, the price does not decrease to $3. It decreases to
$4. What is the margin now?
Solution: For the margin we have,
equity in account
margin =
value of stock owed
$5, 000 + $2, 000 − $4, 000
=
$4, 000
= 75% > 30%(maintenance margin)

Good news. No margin call.

(c) Mr. Handsome covers his short position at $4 and deposits all proceeds to his
margin account. But he still thinks the price will decrease to $3. So he short again
as many shares as possible. After this transaction, Company UGLY receives a
great donation. So its stock price increases to $5. Mr. Handsome has to cover
his short position. Then how much is left in his margin account? More than or
less than his initial funds? Can you provide any intuition for your answer?
Solution: With the new initial investment (which is equity in account in (b))
and initial margin, he can get
3000
= 1875
4 ∗ 40%
shares.
If the price increases to $5 again, he would use 1875 ∗ 5 = $9, 375 to cover the
short position. After this, he would have 7500 + 3000 − 9375 = $1, 125, which is
much less than his initial funds.
The intuition here is that at the time the price was at $4, if he didn’t cover the
short position and reenter the short position, he wouldn’t have lost any money(
but needs to pay the management fee anyway). However, by covering his short
position and reentering the position, he actually shorted more shares (1875 v.s.
1000), thus he lost more money when the stock price increased from $4 to $5 than
he won when the stock price dropped from $5 to $4.