Under pricing can be defined as the price of an initial public offering that is offered below its market price. If the price offered for the stock is below the first trading price of the stock in the market the stock is called as under priced stock. The under pricing of the stock is not a permanent problem or it’s not a permanent condition. This is a temporary situation and the price of the stock will move back towards its intrinsic value as soon as the law of supply and demand becomes stable and balanced within the economy.
There are a number of different reasons due to which the IPOs are under priced. One of the basic reasons of the under pricing of the IPOs is that there are certain concerned related to the liquidity and the uncertainty of the stock price and the level at which the stock is going to trade. The less liquid shares are under priced more as compared to the more liquid shares in the same way the less predictable shares are under priced more often as compared to the predictable shares. This fact is operational because of compensating the investors for the risk they are undertaking by purchasing those shares.
A company must encourage the investor to take part in the IPO of the shares of the company because it is the fact that a company or the IPO issuer tends to know more about the value of the shares as compared to the investors that are purchasing shares.
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