Greenshoe

An over-allotment option (commonly called a "greenshoe") most accurately allows the underwriters to:

1. A.Sell additional shares beyond the base offering size to cover over-allotmentsCorrect. This is the core function of the over-allotment option.
2. B.Force the issuer to repurchase unsold shares at a fixed priceWrong. The greenshoe is about the underwriters selling more shares, not the issuer repurchasing anything.
3. C.Extend the SEC registration statement's effective period indefinitelyWrong. This has nothing to do with the registration statement's effectiveness period.
4. D.Guarantee retail investors a fixed allocation of sharesWrong. The greenshoe addresses total shares sold by underwriters, not allocation guarantees to any investor category.

Why: A greenshoe lets underwriters sell additional shares beyond the base offering size (commonly up to 15% more) to cover over-allotments, giving them flexibility to meet strong demand and to help stabilize the aftermarket price.

Shortly after pricing, a new issue begins trading ABOVE the offering price in the aftermarket, and the syndicate is short shares from over-allotting the deal. What is the underwriters' most natural way to cover that short position given the price move?

1. A.Buy the needed shares in the open market at the now-higher priceWrong. Buying above the offering price to cover a short sold at the offering price locks in a loss; this is not the natural choice when price has risen.
2. B.Do nothing, since a short position from over-allotment does not need to be coveredWrong. A syndicate short position from over-allotting the deal still needs to be covered.
3. C.Exercise the greenshoe to buy the needed shares from the issuer at the original offering priceCorrect. Exercising the over-allotment option covers the short at the offering price, avoiding a loss when the aftermarket price has risen.
4. D.File a new registration statement to issue replacement sharesWrong. Covering a syndicate short from over-allotment is handled through the greenshoe mechanism, not a new registration filing.

Why: When the aftermarket price rises above the offering price, buying shares in the open market to cover the short would mean buying at a higher price than they sold at — a loss. Instead, underwriters typically exercise the greenshoe (over-allotment option) with the issuer, buying the needed shares at the original offering price to cover the short at no loss.

Shortly after pricing, a new issue begins trading BELOW the offering price. The syndicate is short shares from over-allotting the deal. What is the underwriters' most natural way to cover that short position given this price move, and what secondary effect does that action have?

1. A.Exercise the greenshoe to buy from the issuer at the original offering priceWrong. That would mean paying the higher offering price when shares are available more cheaply in the open market.
2. B.Buy shares in the open market at the now-lower price, which also provides stabilizing price supportCorrect. This is the classic stabilizing bid — covering the short at a profit while supporting the aftermarket price.
3. C.Short additional shares to further pressure the price downwardWrong. This would be manipulative and contrary to the stabilizing purpose of covering the short.
4. D.Take no action, since a falling price requires no response from the syndicateWrong. Covering the short and stabilizing the price are exactly what the syndicate manager does in this situation.

Why: When the aftermarket price falls below the offering price, the syndicate manager can cover the short by buying shares in the open market at the now-lower price, at a profit relative to the offering price — and that buying activity itself provides price support (stabilization) for the new issue, which is the classic stabilizing bid.