Auctions - The Most Common Formats
The Dutch Auction
This type of
auction may also be described as an open-outcry
descending price auction or, alternatively, as a “clock auction”.
In the
case of the traditional Dutch auction, the auctioneer starts
proceedings by
suggesting a high asking price. Depending on the response from the
floor, the
price is gradually lowered until one of the participants is willing to
accept
the auctioneer's price. Such a price may also a predetermined reserve price
(which is the
maximum price a buyer is willing to pay for the goods or, conversely,
the
minimum price at which a seller is willing to sell the goods).The
successful participant pays the price
that was finally declared.
The Dutch auction
has derived its name from what must arguably be its best known trading
commodity, viz. the auction of Dutch tulips. The term "Dutch auction"
may also be used to describe online auctions where a number of similar
items
are sold at the same time to an equal number of high bidders. As well
as the
sale of cut flowers in the
Netherlands,
Dutch auctions have also been applied to the sale of perishable goods,
such as
fish and tobacco. In practice, however, the system of Dutch auctions
does not
have a widespread application.
This form of
auctioneering is appropriate when it is
necessary to dispose of the goods quickly, because a sale does not
require more
than one bid. In theory, the format of the bidding and the results from
this
auction are similar to those derived from a sealed first-price auction.
Consider other
applications of the Dutch Auction:
The United States
Department of the Treasury, by way of its
intermediary the Federal Reserve Bank of
New York
(FRBNY), raises funds for the U.S. Government by
the application of a system of Dutch auctions. The FRBNY trades
directly with
primary dealers, such as large banks and broker-dealers, and who submit
their
own bids and those on behalf of their clients by way of the Trading
Room
Automated Processing System ("TRAPS"). In most cases, the primary
dealers are advised of the winning bids within fifteen minutes of the
initial
trade.
As
an illustration, imagine that the sponsor of the issue is
seeking to raise $10 billion in ten-year notes with a 5.125% coupon,
and the
bids are as follows:
$1.00 billion at
5.115%
$2.50 billion at
5.120%
$3.50 billion at
5.125%
$4.50 billion at
5.130%
$3.75 billion at
5.135%
$2.75 billion at
5.140%
$1.50 billion at
5.145%
In the above
illustration, the “% at high” is 66.66%, which means that only $3
billion (or
2/3) of the $4.5 billion at 5.130% will get bonds.
Bids will be
transacted, starting with lowest yield (highest
price), until the entire $10 billion has been raised. This auction will
conclude with a yield of 5.130%, when each bidder will be required to
pay the
same amount.
In
a theoretical sense, this
facet of the Dutch auction format gives rise to more aggressive bidding
since,
in the above illustration, those who bid 5.115% will receive bonds at
the
higher yield (lower price) of 5.130%.
Auctions
– How To Succeed
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