What exactly is a Dutch Auction? A Dutch auction is a method of pricing shares (typically in an IPO) in which the price of the shares offered is gradually reduced until enough bids are received to sell all of the shares. At that price, all of the shares are sold. What is the Process of a Dutch Auction? The purpose of a Dutch auction is to determine the best price for selling a security.What is a Dutch Auction? A Dutch auction is a price discovery process in which the auctioneer starts with the highest asking price and lowers it until it reaches a price level where the bids received will cover the entire offer quantity. Alternatively, a Dutch auction is known as a descending price auction or a uniform price auction. Dutch auctions are appropriate for instances where a large quantity of an item is being offered for sale, as opposed to just a single item. A Dutch auction can be used in an IPOInitial Public Offering (IPO)An Initial Public Offering (IPO) is the first sale of stocks issued by a company to the public. Prior to an IPO, a company is considered a private company, usually with a small number of investors (founders, friends, family, and business investors such as venture capitalists or angel investors. Dutch Auction Process In the Dutch auction process for an IPO, the underwriterUnderwritingIn investment banking, underwriting is the process where a bank raises capital for a client (corporation, institution, or government) from investors in the form of equity or debt securities. The process aims to provide readers with a better understanding of the capital raising or underwriting process does not set a fixed price for the shares to be sold. The company decides on the number of shares they would like to sell and the price is determined by the bidders. Buyers submit a bid with the number of shares they would like to purchase at a specified bid price. A list is created, with the highest bid at the top. The company works down the list of bidders until the total desired number of shares is sold. The price of the offering is determined from the last price covering the full offer quantity. All bidders pay the same price per share. A Dutch auction encourages aggressive bidding because the nature of the auction process means the bidder is protected from bidding a price that is too high. Example #1 Assume that Company XYZ wishes to sell 10 million shares through a Dutch auction. An investor normally creates an account with Company XYZ's underwriter (usually an investment bank), obtains a prospectus, and acquires an access code or bidder identification code to participate in a Dutch auction (Dutch auctions often occur online). Investors declare how many shares they're willing to acquire and how much they're willing to pay throughout the bidding process. The auctioneer, the underwriter, normally starts the auction by offering an unreasonably high price for the security (in this case, $40 per share). It then steadily lowers the price to, say, $36 per share, where two bids for 500,000 shares are received. The underwriter then reduces the price once more, to $35, and receives bids for 4,000,000 shares. After lowering the price to $34, the underwriter receives another 5,000,000 offers; then, before the auction finishes, the underwriter lowers the price to $33 and receives another 3,000,000 bids. The following table summarises the Dutch auction of Company XYZ: The entity chooses the lowest bid with the highest number of shares and finalizes selling the shares at $34 each. As a result, the shares become available to all investors at the lowest rate even though they have placed higher bids. Example #2 In 2004, Google fixed its IPO price at $108 to $135 no bid received. When the price reduce 85 to 95 and start their IPO subscribing. Strick price To understand the strik price we know about the derivative contract . derivative contract A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset (like a security) or set of assets (like an index). The strike price is the price at which it can be bought or sold, When a derivative contract is exercised. The strike price for call options is the price at which the security can be purchased by the option holder; the strike price for put options is the price at which the security can be sold. Examples A stock option, for example, is for 100 shares of the underlying stock. Assume a trader purchases one call option contract with a strike price of $25 on ABC stock. For the option, he pays $150. ABC stock shares are selling for $35 on the option's expiration date. The option's buyer/holder exercises his right to buy 100 shares of ABC for $25 ea ch (the option's strike price). He sells the stock at the current market price of $35 a share right away. He bought 100 shares for $2,500 ($25 x 100) and sells them for $3,500 ($35 x 100). He makes $1,000 on the option ($3,500 – $2,500), minus the $150 premium he paid for it. As a result, his net profit, Thus, his net profit, excluding transaction costs, is $850 ($1,000 – $150). That’s a very nice return on investment (ROI) for just a $150 investment. Selling Call Options The call option seller’s downside is potentially unlimited. As the spot price of the underlying asset exceeds the strike price, the writer of the option incurs a loss accordingly (equal to the option buyer‘s profit). However, if the market price of the underlying asset does not go higher than the option strike price, then the option expires worthless. The option seller profits in the amount of the premium they received for the option. An example is portrayed below, indicating the potential payoff for a call option on RBC stock, with an option premium of $10 and a strike price of $100. In the example, the buyer incurs a $10 loss if the share price of RBC does not increase past $100. Conversely, the writer of the call is in-the-money as long as the share price remains below $100. Puts option A put option gives the buyer the right to sell the underlying asset at the option strike price. The profit the buyer makes on the option depends on how far below the spot price falls below the strike price. If the spot price is below the strike price, then the put buyer is “in-the-money.” If the spot price remains higher than the strike price, the option will expire unexercised. The option buyer’s loss is, again, limited to the premium paid for the option. The writer of the put is “out-of-the-money” if the spot price of the underlying asset is below the strike price of the contract. Their loss is equal to the put option buyer’s profit. If the spot price remains above the strike price of the contract, the option expires unexercised, and the writer pockets the option premium. What is the IPO Process? The Initial Public Offering IPO Process is where a previously unlisted company sells new or existing securities and offers them to the public for the first time. Prior to an IPO, a company is considered to be private – with a smaller number of shareholders, limited to accredited investors (like angel investors/venture capitalists and high net worth individuals) and/or early investors (for instance, the founder, family, and friends). Rferences https://corporatefinanceinstitute.com/resources/knowledge/finance/ipo-process/ https://www.wallstreetmojo.com/dutch-auction/ https://investinganswers.com/dictionary/d/dutch-auction https://www.investopedia.com/terms/s/strikeprice.asp#:~:text=A%20strike%20pric e%20is%20a,the%20security%20can%20be%20sold.
