Securities Industry Essentials (SIE) ExamKnowledge of Capital MarketsHard
A company is planning to issue new common stock to the public. They have chosen a syndicate of underwriters who agree to purchase all of the shares from the issuer at a set price, and then resell them to the public. If the underwriters cannot sell all of the shares, they are responsible for any unsold portion. This type of offering is known as a:
- AStandby Underwriting
- BBest Efforts Underwriting
- CAll-or-None Underwriting
- DFirm Commitment Underwriting
Show answer & explanationAnswer & explanation
Correct answer: D. Firm Commitment Underwriting
In a firm commitment underwriting, the syndicate of underwriters contractually agrees to purchase the entire issue from the issuer. This means they bear the financial risk of any unsold shares, guaranteeing the issuer receives a specific amount of capital.
Why the other options are wrong
- A. Standby underwriting is used in rights offerings, where underwriters agree to purchase any shares not subscribed by existing shareholders.
- B. In a best efforts underwriting, the underwriters act as agents and are not responsible for unsold shares.
- C. All-or-none is a type of best efforts where the offering is canceled if not all shares are sold.
Firm Commitment Underwriting
Firm commitment underwriting is an agreement where the underwriting syndicate guarantees to purchase all of the securities from the issuer and then resell them to the public. The underwriters assume the risk of unsold shares.
- Underwriters guarantee to buy all shares.
- Issuer is assured of receiving capital.
- Underwriters bear the market risk of unsold shares.
- Most common type of underwriting for IPOs.
Memory trick: Firm Commitment: The underwriters are 'firm' in their commitment to buy all shares.