What is an 'Auction Rate'

Auction rate is the interest rate that will be paid on a specific security as determined by the Dutch auction process. The auctions take place at intervals, and the interest rate is fixed until the next auction occurs. This process helps determine the interest rate on Treasury securities.

BREAKING DOWN 'Auction Rate'

The auction rate is also used in other debt securities, such as municipal bonds. This is a good way for both the investor and the issuer to forecast their returns and costs, respectively, as the auctions can be held as often as annually or even weekly. The auction process also allows investors to mitigate reinvestment risk because the interest rate fluctuations are generally less volatile.

A Dutch auction is a public offering auction structure in which the price of the offering is set after taking in all bids to determine the highest price at which the total offering can be sold. In this type of auction, investors place a bid for the amount they are willing to buy in terms of quantity and price. The competitive bids placed by direct bidders in the auction of Treasury securities, which set the yield or auction rate that all auction participants eventually receive, is an example of the Dutch auction process.

Auction rate securities are long-term, variable rate bonds sold through a Dutch auction. They are tied to short-term interest rates and available as both taxable and tax-exempt bonds. Auction rate securities provide benefits to both the bond issuer and investor. Issuers can secure lower cost financing than raising funds through a syndicate of third party banks and the financing process is simpler and more straightforward for investors participating in the auction.

Limitations to Auction Rate Bidding

A Dutch auction fails when there are insufficient investors willing to buy the securities up for bid. Examples include when banks and other financial institutions backed out of the market for auction rate securities in early 2008. This demonstrates the risks of an auction process for a new securities offering compared to the traditional process of relying on third-party agents, most often investment banks, to market the offering and price it based on estimated buyer demand.

Investment banks serve the function of ensuring prospective investors understand the business and competitive landscape of a company going public in an initial public offering or the fundamentals and credit quality of an issuer considering a fixed income offering. Through this due diligence, bankers can gauge what investors are willing to pay and assess whether there is enough demand for the offering to be successful. In an auction, meanwhile, issuers have no assurance that any bidders will show up.

  1. Auction

    An auction is a process where potential buyers place competitive ...
  2. Auction House

    A company that facilitates the buying and selling of assets, ...
  3. Absolute Auction

    An absolute auction is a type of auction where the sale is awarded ...
  4. Reverse Auction

    A reverse auction is a type of auction in which sellers bid for ...
  5. Call Auction

    A call auction is where participants buy or sell units of a good ...
  6. Auction Rate Security - ARS

    An auction rate security (ARS) is a debt security that is sold ...
Related Articles
  1. Investing

    Should you buy a house at auction?

    The traditional real estate market isn't the only place to conduct your home search. Auctions also bring many buying opportunities.
  2. Personal Finance

    Auction Rate Securities: Bidding On The Long Run

    These investments do better with a long-term horizon. Should you buy them before they're going, going, gone?
  3. Investing

    eBay vs. DealDash: Comparing Auction Sites (EBAY, PYPL)

    Learn how the bidding process works at DealDash and eBay, and discover the potential pitfalls when making bids at these auction sites.
  4. Managing Wealth

    Top Ways To Profit From Storage Auctions

    Here are some extremely valuable tips to help you become an expert at finding deals at storage auctions.
  5. Investing

    The History Of The T-Bill Auction

    Learn how the U.S. found the perfect solution to its debt problems and ended up creating one of the largest markets in the world.
  6. Investing

    Banks Take Extra $3.5 Billion Cash Ahead of Brexit

    As liquidity concerns grow for European banks heading into next week's Brexit vote, the Bank of England is holding additional Repo auctions to ensure banks have enough liquidity heading into ...
  7. Insights

    President Trump’s Old Ferrari Auctioned After Speed Bump

    A Ferrari formerly owned by Donald Trump—the only president to have owned a supercar—was auctioned for $270,000.
  8. Tech

    E&Y Auctioning Last of Seized Bitcoin from Silk Road

    Auditing firm Ernst & Young will be auctioning off the last of the pirate booty seized from the black market site once known as Silk Road.
  9. Investing

    T-Mobile Stock Hits All-Time High on M&A Talk

    Merger speculation heated up as the FCC begins to wrap up its auction of wireless spectrum.
  10. Trading

    Credit Default Swaps: What Happens in a Credit Event?

    The credit crisis of 2008 prompted important changes to the settlement of credit default swaps.
  1. How is the risk-free rate determined when calculating market risk premium?

    Learn how the risk-free rate is used in the calculation of the market risk premium, and understand why T-bills provide the ... Read Answer >>
  2. Which factors most influence fixed-income securities?

    Learn about the main factors that impact the price of fixed-income securities, and understand the various types of risk associated ... Read Answer >>
  3. Who Are the Key Players in the Bond Market?

    The bond market can be broken down into three main groups: issuers, underwriters and purchasers. Learn what each set of players ... Read Answer >>
Trading Center