Corporate Finance Homework: IPO Underpricing, EMH and Stock Analysis

This homework assignment delves into key concepts in corporate finance. It begins by defining the underpricing phenomenon in Initial Public Offerings (IPOs) and explores its underlying causes, such as attracting uninformed investors and benefiting investment banks. The assignment then provides the formula for calculating IPO underpricing. Furthermore, it explains the role of investment banks as market makers, emphasizing their function in maintaining market liquidity through bid-ask spreads. The assignment then tests the Efficient Market Hypothesis (EMH) by examining the impact of the Iranian retaliation event on Saudi Aramco's stock price, analyzing its movement before, during, and after the event, and determining its consistency with the EMH. Finally, the assignment analyzes the stock performance of SABIC and SADAFCO over a five-year period, comparing their performance to the market index and drawing conclusions about correlation, volatility, and diversification potential.

CORPORATE FINANCE

Table of Contents
Answer 1)...................................................................................................................................2
Answer 2)...................................................................................................................................2
Answer 3)...................................................................................................................................2
Answer 4)...................................................................................................................................2
1).............................................................................................................................................2
2).............................................................................................................................................3
3).............................................................................................................................................3
4).............................................................................................................................................3
Answer 5)...................................................................................................................................4
References..................................................................................................................................5

Answer 1)
Under-pricing phenomenon is referred to as the practice in which the listing of the
initial public offering securities is done at a price that is lower than the real value or the
market value of the securities (IPO of old company) or the company (IPO of a new
company). There are various reasons for the performance of the IPO under-pricing. The
prime reason is the attracting the uninformed investors. There are several investors in the
market that do not have information regarding the worth of the shares being issued and do not
know what kind of company they are placing their investments in. The only goal is to earn
the returns; hence the under-pricing the IPO attracts such customers. As per the yet another
theory of investment back conflict theory, the under-pricing benefits the investment banks
who act as the underwriter to the issue, because the original under writing fees is not charged
much. Thus, the under writing is done to benefit such under writers (Sohail Khalid, Raheman,
Zakaria & Farhat, 2018).
Answer 2)
The under-price is denoted as the percentage change of offer price to market price as
seen on the end of the first trading day of the stock. The formula for the calculation of the
under-pricing of an IPO is stated as follows (Albada, 2020).
Under Price = (Market Price – Offered Price) / Offered Price
Answer 3)
By making a market means an investment banks has a price for buying the security as
well as selling the security. The investment banks hold the responsibility of either one
security, or a group of securities and they aim to earn the profits on the difference between

the purchase and the sell price. Thus, the profit of the investment banks lies in the difference
of the ask buy spread. Thus, the investment banks function in between the two prices to
maintain the liquidity in the market (Hopkinson, 2017).
Answer 4)
1)
The event that has been chosen is Iranian Retaliation which happened over the last few weeks
and Saudi Aramco one of the largest companies when pulled off its biggest IPO ever. This
event had a huge impact on the share prices of Saudi Aramco and the stock dropped roughly
by 2% and overall crude oil prices fell by 6%.
2)
Saudi Aramco
Before Date Adj Close Average returns
12/26/2019 35.260
12/29/2019 35.310 0.14%
12/30/2019 35.061 -0.71%
12/31/2019 35.160 0.28%
1/1/2020 35.011 -0.43%
1/2/2020 35.061 0.14%
1/5/2020 34.462 -1.71%
During Date Adj Close Average returns
1/6/2020 34.500
1/7/2020 34.350 -0.43%
1/8/2020 33.250 -3.20%
1/9/2020 32.100 -3.46%
1/12/2020 33.220 3.49%
1/13/2020 32.000 -3.67%
After Date Adj Close Average returns
1/13/2020 34.661
1/14/2020 34.761 0.29%
1/15/2020 34.611 -0.43%
1/16/2020 34.511 -0.29%

1/19/2020 34.262 -0.72%
1/20/2020 34.511948 0.73%
3)
As per the current observation, the event did impact the price of the company. During 5th
January, the price was 34.462 and when IPO was cancelled the company’s price fell to 34.35
and eventually 32.10 on 9th January. The negative returns of -3.46% were achieved by the
company. Thereafter the situation improved a bit and yet again stood stagnant at negative
factors. This implies that event resulted in the decline of the share price (Ziady, 2020).
4)
According to the EMH, the relationship exists between past price and volume data with
future movements. Secondly when the share prices adjust to publicly available new news and
nay piece of information such as in case of Saudi Aramco, and in an unbiased manner, so that
no excess returns can be made trading on that information. Hence, it is clearly evident that it
is not consistent with Efficient Market Hypothesis (Suliman, 2017).

Answer 5)
As evident from the below, it can be stated that the Stocks SABIC and SADAFCO
have outperformed the market in terms of the overall change occurred in the previous five
years. It is to be noted that while the percentage change of TASI is -33.78%, that of SABIC
and SADAFCO are 0.02% and 0.50% respectively.
SABIC AVERAGE = 0.02%
SADAFCO AVERAGE = 0.50%
Correlation Matrix
SABIC SADAFCO
SABIC 1
SADAFCO 0.086929 1

References
Albada, A. (2020). IPO Research in Malaysia: A Review of Under-Pricing
Phenomenon. International Journal of Banking and Finance, 13(1), 95-118.
Hopkinson, G. C. (2017). Making a market for male dairy calves: alternative and mainstream
relationality. Journal of Marketing Management, 33(7-8), 556-579.
Sohail Khalid, M., Raheman, A., Zakaria, M., & Farhat, R. (2018). IPO underpricing
phenomenon on the karachi stock exchange.
Suliman, O. (2017). Efficient market hypothesis. The American Middle Class: An Economic
Encyclopedia of Progress and Poverty [2 volumes], 70, 126.
Ziady, H. (2020). Saudi Aramco has lost $200 billion in value since its post-IPO peak. Iran
fears aren't helping. Retrieved from
https://edition.cnn.com/2020/01/06/investing/saudi-aramco-stock-price-oil/index.html

Appendix 1
Date SABIC SADAFCO % SABIC % SADAFCO
4/1/2015 73.54 107.33 11.42% 8.35%
5/1/2015 81.94 116.30 -0.71% 2.91%
6/1/2015 81.36 119.68 -5.41% -3.64%
7/1/2015 76.96 115.33 -16.53% -3.82%
8/1/2015 64.24 110.93 0.33% 4.84%
9/1/2015 64.46 116.29 6.96% -1.85%
10/1/2015 68.94 114.15 -3.41% -6.28%
11/1/2015 66.59 106.98 -5.89% -10.14%
12/1/2015 62.67 96.13 -7.99% 6.98%
1/1/2016 57.66 102.84 3.32% 13.35%
2/1/2016 59.58 116.58 2.90% -8.78%
3/1/2016 61.31 106.34 13.56% 10.57%
4/1/2016 69.62 117.58 -0.03% 11.23%
5/1/2016 69.60 130.78 -0.81% -2.55%
6/1/2016 69.04 127.45 2.47% 3.32%
7/1/2016 70.75 131.68 -0.60% -6.69%
8/1/2016 70.32 122.87 0.92% -11.11%
9/1/2016 70.97 109.22 4.31% -6.65%
10/1/2016 74.03 101.95 11.80% 13.17%
11/1/2016 82.76 115.39 -1.85% -4.96%
12/1/2016 81.23 109.66 3.23% -7.23%
1/1/2017 83.85 101.73 1.04% 8.44%
2/1/2017 84.73 110.32 -0.26% 5.59%

3/1/2017 84.51 116.49 2.07% -3.97%
4/1/2017 86.26 111.86 0.72% -0.20%
5/1/2017 86.88 111.64 4.62% 1.01%
6/1/2017 90.89 112.77 -4.61% -3.71%
7/1/2017 86.70 108.59 3.85% -1.51%
8/1/2017 90.04 106.95 4.04% 2.04%
9/1/2017 93.68 109.13 -3.59% 4.17%
10/1/2017 90.31 113.68 1.51% 4.00%
11/1/2017 91.67 118.23 0.99% 0.00%
12/1/2017 92.58 118.23 -0.20% -9.37%
1/1/2018 92.40 107.15 2.36% 2.76%
2/1/2018 94.59 110.11 11.92% -1.17%
3/1/2018 105.86 108.81 -1.55% -8.32%
4/1/2018 104.23 99.76 15.87% -16.39%
5/1/2018 120.77 83.41 -3.22% 4.32%
6/1/2018 116.88 87.01 2.06% -5.63%
7/1/2018 119.28 82.12 -2.17% 4.57%
8/1/2018 116.69 85.87 -0.48% -1.10%
9/1/2018 116.14 84.93 2.91% 0.00%
10/1/2018 119.52 84.93 -7.41% 5.56%
11/1/2018 110.66 89.64 -1.02% 5.68%
12/1/2018 109.53 94.74 5.68% 1.74%
1/1/2019 115.75 96.39 -0.33% 2.00%
2/1/2019 115.37 98.32 1.14% 1.96%
3/1/2019 116.69 100.24 0.32% 12.50%
4/1/2019 117.07 112.77 -6.76% -0.85%

5/1/2019 109.15 111.81 2.50% -0.86%
6/1/2019 111.88 110.85 -6.28% 8.49%
7/1/2019 104.85 120.26 -6.98% 2.12%
8/1/2019 97.53 122.81 -7.91% 7.03%
9/1/2019 89.82 131.44 -2.36% -5.22%
10/1/2019 87.70 124.57 3.76% -2.99%
11/1/2019 91.00 120.85 3.19% 16.07%
12/1/2019 93.90 140.27 -6.82% 3.80%
1/1/2020 87.50 145.60 -8.34% -5.08%
2/1/2020 80.20 138.20 -16.96% -5.93%
3/1/2020 66.60 130.00 -0.15% -2.31%
3/22/2020 66.50 127.00 -100.00% -100.00%