Underwritten, Syndicated Offerings and Shelf Registration

Issuers sell bonds initially in primary bond markets. Existing bonds are subsequently traded among investors in secondary bond markets. A bond can be sold in a public offering, in which anybody may buy the bonds, or by private placement, in which only a selected group of investors can participate. Investment banks serve as intermediaries between the organization issuing the securities and the investors who purchase them.

Underwritten Offering

In an underwritten offering, the investment bank guarantees the sale of the bonds at a negotiated offering price. The underwriter takes on the risk of buying the securities and then sells them to investors.

Best Effort Offering

In contrast, in a best effort offering, the investment bank functions only as a broker for a commission. As such, there is less incentive to sell the securities.

Syndicated Offering

For larger bond issuances, the underwitter is usually a group (or syndicate) of investment banks. A lead underwriter invites other investment banks to join the syndicate. If the offering price is set too high/(low), the offering will be under/(over) subscribed resulting in insufficient/(over) demand.

Shelf Registration

Shelf registration allows authorized issuers to offer additional bonds to the public without a new offering. For instance, Tesco used a shelf registration for a series of issues. Most sovereign bonds are sold via a public auction. Private placements are non-underwritten offerings of bonds that are sold only to a small group of investors such as insurance companies and pension funds.

Public Auction

A public auction is a mechanism by which the public is invited to place bids on certain issues. In the US, the winning bidders all pay the same price and receive the same coupon rate for the securities. In Canada and Germany, multiple-price auctions exist, generating multiple prices and coupon rates for the same bond issue.

Question

Under which type of offering does the investment bank takes on the least amount of risk?

A. Underwritten offer

B. Best effort offer

C. Syndicated offer

Solution

The correct answer is B.

In a best effort offering, the investment bank functions only as a broker in return for a commission. Therefore, the bank does not bear much risk

Option A is incorrect. In an underwritten offer, the investment bank guarantees the sale of the bonds. If the bank is unable to sell all of the securities, it has to either keep them or sell them at a loss.

Option C is also incorrect. A syndicated offering is similar to an underwritten offer except that the underwritter is made up of a group of investment banks.

Reading 51 LOS 51c:

Describe mechanisms available for issuing bonds in primary markets

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