1 ‘In a public share issue, the probability of receiving an allocation of an underpriced security is less than or equal to the probability of receiving an allocation of an overpriced issue.’ Discuss this statement in the context of initial public offerings. (25 marks)

Ai Due Fanali SA has decided to undertake a rights issue that will raise €288 million. The current share price is

€4.50 and there are 160 million shares in circulation. They have to make a decision on whether to underwrite the rights issue. The underwriting fee will be 2 per cent of proceeds if the shares are offered at a 20 per cent discount. Ai Due Fanali’s finance director believes that a discount of 40 per cent will avoid the need for underwriting altogether.