Sale of a New Issue
A municipal security issuer may choose to sell a new issue through negotiation or through an auction, known as competitive sale. In a negotiated sale, the process begins with the issuer choosing a managing underwriter (or sole underwriter in some cases). The issuer and the underwriter then negotiate the terms of the offering. In a competitive sale, the issuer holds a sealed bid auction to receive bids from competing underwriters and the issuer may choose the underwriter offering terms which result in the lowest cost of financing.
Some of the terms of the offering determined during the underwriting process include the interest rate, maturity and initial offering price. In a negotiated sale, these are determined through negotiation between the underwriter and issuer. In a competitive sale, most of these terms are proposed by the bidding underwriters.
Initial Offering Prices and Yields
The initial offering price is the price at which a new issue of municipal securities is offered to the public at the time of original issuance. In some cases, the initial offering price is set at a premium or discount to par value. Municipal bonds normally are sold to investors based on the yield of the transaction -- an expression of annual rate of return on an investment -- and takes into account any premium or discount from the par value. For example, a transaction priced at 100% of par value of a bond will have a yield equal to the stated interest rate on the bond often referred to as the coupon, while a transaction priced at a discount to par value will have a yield higher than the coupon.
The specific yields at which new issues are sold reflect a number of factors relating to the market value of the securities being offered. These include characteristics of the specific securities being offered -- type of security, terms and features and credit quality, for example -- as well as the general interest rate environment and credit market conditions.
Underwriting Spread
The gross underwriting spread, which represents expenses and compensation to the underwriter distributing new issue securities to investors, is the difference between the price paid by investors and the amount paid by an underwriter to the issuer. For example, if the issuer issues $10,000,000 in bonds for sale to investors at an initial offering price of par (face value), and the underwriting spread is 1%, the issuer would receive $9,900,000. The exact amount received by an underwriter depends on whether the initial offering price was obtained for all of the securities in the issue.