How to Calculate Gross Profit an Underwriter Makes in Sale Bonds
Corporations and governments normally sell bonds and other securities through a broker/dealer such as a bank that acts as the underwriter. The underwriter takes on the responsibility and the market risk of selling the bond issue to investors, purchasing the bonds at a discount and selling at a profit.
An underwriter’s gross profit is equal to the “spread,” or difference between the buying and selling price. If it prices an issue too low, then the bond issuer may not make as much money as it could; if it prices too high, then investors may not buy, or may have to pay higher prices.
4 Steps to Calculate Gross Profit an Underwriter Makes in Sale Bonds
1. Obtain a copy of the public notice or other disclosure documents.
You can do this by contacting the underwriter, who is required to publish the details of the bond issue’s terms and structure. This document will tell you the discount from the par value of the bonds the underwriter is granted. For example, the underwriter might be paying 99.0 percent of the par value.
2. Contact a bond broker or the underwriter and ask for the price the underwriter has set for the bonds.
This is subject to change depending on market conditions up to the time of sale, so be sure you have current pricing information. Normally bond prices are listed as a percentage of par value, rather than in dollar amounts.
3. Subtract the discount percentage from the sale price percentage to find the underwriter’s spread.
For example, if the underwriter paid 99.0 percent and the bonds are priced at a premium of 100.50 percent of par, the spread is equal to 1.50 percent of the par value.
4. Look on the disclosure documentation for the total size of the bond issue.
This will be equal to the par value of all the bonds in the issue combined. Multiply by the underwriter’s spread to find the gross profit the underwriter makes. If the spread is 1.50 percent and the bond issue is for $10 million, the underwriter’s gross profit is 1.5 percent multiplied by $10 million, or $150,000.
Tips and Warnings
- Not all bonds, particularly municipal bonds, are sold through underwriters. In a “private placement,” some or all of a municipal bond issue is marketed directly to investors with a placement agent as the only intermediary.
- Requirements for bond issue procedures vary from state to state and with the type of bond. For example, some underwriter discounts are based on competitive bidding while others are negotiated between the issuer and the underwriter. Competitive bidding is often legally mandatory for general obligation municipal bonds.
You Might Also Like :: How to Develop a Prospectus for Bonds