What is Laddering
Laddering is the promotion of inflated pre-IPO prices for the sake of obtaining a greater allotment of the offering. Laddering is an illegal IPO practice in which the underwriter engages in the sale of IPO shares to clients with the implicit agreement that more shares will be purchased post IPO, leading to big gains for both parties. Once the price increases a certain level, "insiders" then sell their shares and take their profits.
BREAKING DOWN Laddering
An underwriter will push up the issue price of an IPO through promotion, in order to please the issuer and secure a larger allotment. By agreeing to allocate additional shares to choice clients, the underwriter and clients can make big gains on the IPO shares, while the firm offering shares in the IPO are happy with the underwriter for creating increased market value.
Laddering is also the name of an investment technique that involves purchasing multiple financial products with different maturity dates.
Laddering can be used to free up capital. For example, a person may purchase a shorter term bond in the event that he needs the capital soon to fund his children's tuition. A person might purchase longer term bonds as a retirement investment, with a more favorable rate, assuming the economy is experiencing a normal yield curve during this time.
Laddering can also be the basis for an overall retirement planning approach for all retirement investments. The basic point of the concept is to seperate CDs, cash, bonds, annuities, and others into different "ladders" or "buckets" or "baskets," depending on when the asset is expected to be liquidated to fund the retirement revenue stream. Low-risk assets are used at the start of retirement (and usually have an expected lower rate of return, due to lacking a risk premium). Higher-risk assets would be placed in a basket used at the end of retirement.
Laddering can help an investor create a well-diversified portfolio and achieve a variety goals. For instance, it can decrease interest rate risk by holding both short-term and long-term bonds. If rates are rising, as one bond matures the funds can be re-invested into higher yield bonds. The practice of laddering can also help an investor manage re-investment risk because as one bond in the ladder matures, the cash is re-invested, but it only represents a portion of the total portfolio. Even if prevailing rates at the time of re-investment are lower than the previous bond was returning, the smaller amount of reinvestment dollars mitigates the risk of investing a lot of cash at a low return. Laddering can also help maintain steady cash flows to encourage regular saving for investors looking for an income-producing portfolio.