Methods of Issuing Securities for Cash

There are three elementary ways in which securities are issued for cash. These are firm commitment, best efforts and Dutch auction underwriting. In all three cases, financial institutions underwrite the securities to cover for the risk involved. However, the way in which the offering is done differs at different levels (McGraw-Hill 2014).

In the firm commitment method, the investment bank buys the securities purchases the securities at a price lower than the offering price. This is known as underwriting. He accepts the risk of not being able to resell the securities. Investment bankers may opt to minimise the risk by combining to form an underwriting group also known as a syndicate. They then elect a lead manager who is made responsible for all aspects of the issue. The other investment bankers have a responsibility of selling the securities to their customers at the offering price. The difference between the buying price and the offering price is known as a spread (McGraw-Hill 2014).

In the best efforts method, the underwriter does not buy the securities as in the firm commitment method. Instead, he only acts as an agent and earns a commission for every security sold. All the securities that are not sold by the investment bank are then withdrawn. This is unlike in the firm commitment method, where the underwriter is left with the option of lowering the offering price (McGraw-Hill 2014).

In Dutch auction underwriting, there is no permanent offering price for the securities. Instead, the investment bank welcomes bids from investors. The submitted bids are then used to determine the offering price. While making this decision, investment banks ensure that they give the highest bid that will ensure that all securities are sold (McGraw-Hill 2014).

In most cases, the lead underwriter is permitted to purchase the securities if the price at the market falls below the offering price. This ensures for the stability of the market. Underwriters may also opt out of their syndicate and sell their securities at any price the market allows if the securities fail to move.

References

McGraw-Hill(Retrieved on 17th may 2014). The Cash Offer Retrieved from http://www.connect.mcgraw-hill.com/sites/0077333403/student_view0/ebook/chapter20/chbody1/20_3_the_cash_offer.htm

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