Legal Definitions - underwriting spread

The underwriting spread refers to the difference between the price at which an investment bank (the underwriter) purchases a new issue of securities from the issuer (e.g., a company or government) and the higher price at which the underwriter then sells those securities to the public. This spread represents the underwriter's compensation for their services, which include advising the issuer, marketing the securities, bearing the risk of not being able to sell all the securities, and distributing them to investors. It covers their expenses and profit margin for facilitating the transaction.

• Example 1: Initial Public Offering (IPO)

  A rapidly growing electric vehicle startup decides to go public through an Initial Public Offering (IPO). An investment bank agrees to underwrite the IPO, purchasing 20 million shares from the company at $24.00 per share. The investment bank then offers these shares to institutional investors and the public at $25.50 per share.

  Explanation: The underwriting spread in this scenario is $1.50 per share ($25.50 selling price - $24.00 purchase price). This $1.50 per share compensates the investment bank for its role in structuring the IPO, assessing market demand, marketing the shares to potential investors, and taking on the financial risk that not all shares might be sold at the public offering price.

• Example 2: Municipal Bond Issuance

  A state government plans to issue $500 million in municipal bonds to fund improvements to its highway system. A syndicate of investment banks acts as underwriters, agreeing to purchase these bonds from the state at 99.2% of their face value (i.e., $992 for a $1,000 bond). The syndicate then sells these bonds to individual and institutional investors at 100% of their face value (i.e., $1,000 for a $1,000 bond).

  Explanation: Here, the underwriting spread is $8 per $1,000 bond ($1,000 selling price - $992 purchase price). This spread covers the underwriters' costs and profit for facilitating the bond issuance, including legal and administrative fees, marketing the bonds to a diverse investor base, and guaranteeing the sale of the bonds to the state.

• Example 3: Corporate Debt Offering

  A large telecommunications company decides to issue new corporate bonds to refinance existing debt. An underwriter agrees to purchase $1 billion worth of these bonds from the company at a price of 98.75% of their par value. The underwriter then re-offers these bonds to institutional investors and the broader market at 99.50% of their par value.

  Explanation: The underwriting spread in this debt offering is 0.75% of the par value (99.50% selling price - 98.75% purchase price). For a $1,000 bond, this would be $7.50. This percentage represents the underwriter's compensation for advising the company on the bond structure, marketing the bonds to a targeted investor base, and managing the distribution process.