Securities Industry Essentials (SIE) ExamKnowledge of Capital MarketsMedium
A company is issuing new shares of common stock to the public for the very first time. This offering will be facilitated by an investment bank that commits to buying any unsold shares. This arrangement describes which type of underwriting?
- AAll or None Underwriting
- BBest Efforts Underwriting
- CStandby Underwriting
- DFirm Commitment Underwriting
Show answer & explanationAnswer & explanation
Correct answer: D. Firm Commitment Underwriting
In a firm commitment underwriting, the investment bank (underwriter) agrees to purchase the entire issue from the issuer and then resell it to the public, assuming the risk of unsold shares.
Why the other options are wrong
- A. All or none is a type of best efforts where the offering is canceled if not all shares are sold.
- B. In a best efforts underwriting, the underwriter acts as an agent and does not guarantee the sale of all shares.
- C. Standby underwriting is used in rights offerings where the underwriter agrees to buy unsubscribed shares.
Firm Commitment Underwriting
An underwriting agreement where the investment bank commits to buying all shares from the issuer, assuming the risk of unsold shares.
- Underwriter acts as a principal.
- Issuer is guaranteed to receive the capital.
- Highest risk for the underwriter.
Memory trick: Firm Commitment: 'Fixed' and 'Final' purchase.