Reallowance

Larkfield Corp's offering is priced at 30 dollars per share with a gross underwriting spread of 1.50 dollars, made up of a 0.30 dollar manager's fee, a 0.50 dollar underwriting fee and a 0.70 dollar selling concession. Ironvale Capital belongs to neither the syndicate nor the selling group but wants shares to fill a customer order, and the manager grants it a reallowance. That reallowance is:

1. A.Equal to the full 1.50 dollar gross spreadThe gross spread is the issuer's total cost and is never paid to a single outside dealer.
2. B.Equal to the 1.20 dollar total takedown available to a syndicate memberThe takedown belongs to syndicate members who assume underwriting risk.
3. C.A portion of the 0.70 dollar selling concession, and therefore less than 0.70 dollars per shareCorrect. A reallowance is carved out of the concession for a dealer outside both the syndicate and the selling group.
4. D.Equal to the 0.30 dollar manager's feeThe manager's fee compensates the lead underwriter for running the deal.

Why: The spread breaks down in layers. The manager keeps its fee off the top. A syndicate member that sells shares earns the total takedown, which is the spread less the manager's fee, or 1.20 dollars here. A selling group member that is not at risk on the issue earns only the selling concession of 0.70 dollars. A firm outside both groups can still obtain shares, but only at a reallowance carved out of the concession, so it is by definition smaller than 0.70 dollars. Each layer earns less as the firm's commitment to the deal decreases.

A corporate offering is priced at 20 dollars per share with a gross underwriting spread of 1.20 per share, made up of a 0.20 manager's fee, a 0.30 underwriting fee, and a 0.70 selling concession. A SELLING GROUP member places 10,000 shares. What does that firm earn?

1. A.3,000 dollarsThis uses the 0.30 underwriting fee, which selling group members do not receive.
2. B.10,000 dollarsThis adds the 0.30 underwriting fee to the concession, which is what a syndicate member would earn, not a selling group member.
3. C.12,000 dollarsThis credits the entire 1.20 gross spread, including the manager's fee, to one selling firm.
4. D.7,000 dollarsCorrect. The selling concession of 0.70 per share on 10,000 shares equals 7,000 dollars.

Why: The gross spread splits three ways. A selling group member is not part of the syndicate: it takes no underwriting risk and receives only the selling concession. That is 0.70 times 10,000 shares, or 7,000 dollars. The clue is the phrase selling group member, which tells you which slice of the spread applies.