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What is a 'Dutch Auction'

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.

A Dutch auction also refers to a type of auction in which the price on an item is lowered until it gets a bid. The first bid made is the winning bid and results in a sale, assuming that the price is above the reserve price. This is in contrast to typical options, where the price rises as bidders compete.

BREAKING DOWN 'Dutch Auction'

Public Offering Dutch Auction

If a company is using a Dutch auction initial public offering (IPO), potential investors enter their bids for the number of shares they want to purchase as well as the price they are willing to pay. For example, an investor may place a bid for 100 shares at $100 while another investor offers $95 for 500 shares.

Once all the bids are submitted, the allotted placement is assigned to the bidders from the highest bids down, until all of the allotted shares are assigned. However, the price that each bidder pays is based on the lowest price of all the allotted bidders, or essentially the last successful bid. Therefore, even if you bid $100 for your 1,000 shares, if the last successful bid is $80, you will only have to pay $80 for your 1,000 shares.

The U.S. Treasury uses a Dutch auction to sell its securities. To help finance the country's debt, the US Treasury holds regular auctions to sell Treasury bills (T-bills), notes (T-notes), and bonds (T-bonds), collectively known as Treasuries. Prospective investors submit bids electronically through TreasuryDirect or the Treasury Automated Auction Processing System (TAAPS) which accepts bids up to 30 days in advance of the auction. Suppose the Treasury seeks to raise $9 million in two-year notes with a 5% coupon. Let's assume the submitted bids are as follows:

  • $1 million at 4.79%
  • $2.5 million at 4.85%
  • $2 million at 4.96%
  • $1.5 million at 5%
  • $3 million at 5.07%
  • $1 million at 5.1%
  • $5 million at 5.5%

The bids with the lowest yield will be accepted first since the issuer will prefer to pay lower yields to its bond investors. In this case, since the Treasury is looking to raise $9 million, it will accept the bids with the lowest yield up to 5.07%. At this mark, only $2 million of the $3 million bid will be approved. All bids above the 5.07% yield will be accepted, and bids below will be rejected. In effect, this auction is cleared at 5.07%, and all successful bidders receive the 5.07% yield.

The Dutch auction also provides an alternative bidding process to IPO pricing. When Google launched its public offering, it relied on a Dutch auction to earn a fair price.

Lowest Bidding Dutch Auction

At a Dutch Auction, prices start high and are dropped successively until a bidder accepts the going price. Once a price is accepted, the auction ends. For example, the auctioneer starts at $2,000 for an object. The bidders watch the price decline until it reaches a price that one of the bidders accepts. No bidder sees the others’ bids until after his or her own bid is formulated, and the winning bidder is the one with the highest bid. So, if there are no bidders at $2,000, the price is lowered by $100 to $1,900. If a bidder accepts the item of interest at, say the $1,500 mark, the auction ends. 

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