Issuance & underwriting

Issuance

When a bond is issued, thousands of bonds are typically sold by one issuer. Sometimes all bonds being issued maintain the same issue and maturity date, but sometimes issuers will structure them differently. Let’s take a look at the various types of bond issuance formats:

Term

• All bonds issued on the same day and mature on the same day
• Example:
  • 1,000 bonds issued January 1, 2023
  • 1,000 bonds mature on January 1st, 2033

Serial

• All bonds are issued on the same day, but mature on different days
• Example:
  • 1,000 bonds issued on January 1, 2023
  • 500 bonds mature on January 1, 2028
  • 500 bonds mature on January 1, 2033

Series

• Bonds are issued on different days, but all mature on the same day
• Example:
  • 500 bonds issued on January 1, 2023
  • 500 bonds issued on January 1, 2028
  • 1,000 bonds mature on January 1, 2033

Debt securities are structured in different ways depending on the type and issuer. Most corporate and US Government bonds are issued in term format, while many municipal (city and state government) bonds are issued in serial format. Bonds funding construction-related projects are commonly issued in series format. While these are the generalities, there are some exceptions we’ll learn about later.

We’ll also learn how bonds are quoted in future chapters.

You won’t need to know why bonds are quoted differently; just assume some bonds are quoted with prices and some with yields. Let’s look at some examples:

Price quote example

• Bond trading at 95

Yield quote example

• Bond trading at a 6% yield

You’ll learn how to translate each of these quotes, but they are obviously different. One refers to the price of a bond (95 = 95% of par, which is $950), while the other refers to yield (which is the overall rate of return on a bond).

Bonds issued in certain formats are quoted in specific ways. Term bonds are most often quoted in price, or percentage of par form. As discussed in the paragraph above, a bond quoted at 95 means the bond is trading at 95% of par; hence, it is called a percentage of par quote. Alternatively, it can also be referred to as a dollar or term quote.

Serial bonds are most often quoted in yield form. Yield quotes are also referred to as serial quotes and basis quotes. You may have heard of a basis point, which is equal to .01%. In your career, you’ll find basis points utilized when discussing performance. For example:

“The company’s revenues exceeded expectations by 50 basis points.”

This is a fancy way of saying the company exceeded revenue expectations by 0.50%. You may encounter basis points on the exam, and there are a few ways to remember what a basis point is:

• 1 basis point = 0.01%
• 100 basis points = 1.00%

If basis points are mentioned in a bond quote, it refers to a bond’s yield. This is why yield quotes are sometimes referred to as basis quotes.

Underwriting

Underwriters are in the business of marketing securities to the investing public on behalf of issuers (in the primary market). Issuers pay significant amounts of money to underwriters to help them raise capital (money) by selling their securities. For example, the underwriters for Uber’s initial public offering (IPO) in 2019 collected over $100 million in fees. Many factors determine how much an underwriter can collect, but their commitment is a significant component.

Underwriting commitments can be firm or best efforts. Whether the issuer or the underwriter keeps any unsold securities determines the commitment. For example, if an underwriter attempts to sell $100 million of bonds but only sells $75 million, who is stuck with the $25 million in unsold bonds?

If a bond is issued on a firm commitment basis, the underwriter is stuck with the unsold securities. In our example above, the underwriter would pay the issuer somewhere close to $100 million for the entire bond offering and try to profit when flipping (reselling) it to their customers. However, if any bonds go unsold, the underwriter is stuck with those bonds.

If a bond is issued on a best efforts basis, the issuer is stuck with the unsold securities. This type of commitment awards the underwriter an underwriting fee for every unit sold but does not require the underwriter to keep the unsold shares or bonds.

Firm commitments are riskier for underwriters and require a higher underwriting fee than best efforts commitments. As with everything else in finance, more risk provides more return!