B Com Exam > B Com Notes > Financial Markets and Institutions > Underwriting - Investment Banking, Financial Markets and Institutions
Underwriting - Investment Banking, Financial Markets and Institutions | Financial Markets and Institutions - B Com PDF Download
Definition: Underwriting is one of the most important functions in the financial world wherein an individual or an institution undertakes the risk associated with a venture, an investment, or a loan in lieu of a premium. Underwriters are found in banking, insurance, and stock markets.
The nomenclature 'underwriting' came about from the practice of having risk takers to write their name below the total risk that s/he undertakes in return for a specified premium in the early stages of the industrial revolution.
Description: Today, underwriting is one of the key functions in the financial world and has become a discipline of sorts in itself.
Underwriting in insurance
In the insurance world, underwriters determine whether an insurance agency should undertake the risk of insuring a client. They determine the risk and exposure of clients and also how much insurance should be granted to a client, how much they should pay for it and whether or not to offer an insurance policy to the client in the first place.
Underwriting in stock market
In the securities market, underwriting involves determining the risk and price of a particular security. It is a process seen most commonly during initial public offerings, wherein investment banks first buy or underwrite the securities of the issuing entity and then sell them in the market. This ensures that the issuers of the security can raise the full amount of capital while earning the underwriters a premium in return for the service.
Investors benefit a lot from the underwriting process as the information provided by an underwriting agency can help them take a more informed buying decision. An underwriter who holds a large chunk of the securities of a particular company or is the market maker for such a security provides the core liquidity for the security and enhances price stability and distribution.
Underwriting in banking
Underwriters in the banking sector perform the critical operation of appraising the credit worthiness of a potential customer and whether or not to offer it a loan. They appraise the credit history of the customer through their past financial record, statements, and value of collaterals provided, among other parameters.
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FAQs on Underwriting - Investment Banking, Financial Markets and Institutions - Financial Markets and Institutions - B Com
| 1. What is underwriting in investment banking? |  |
Ans. Underwriting in investment banking refers to the process of assessing and evaluating the financial risks associated with a particular investment or security offering. Underwriters act as intermediaries between the issuer of the security and potential investors, determining the appropriate price and quantity of the securities to be offered. They also ensure compliance with regulatory requirements and help to mitigate risks for both the issuer and investors.
| 2. How does underwriting work in financial markets and institutions? | |
Ans. Underwriting in financial markets and institutions involves a thorough analysis of the financial health, creditworthiness, and market conditions related to a specific investment or security. Underwriters evaluate the potential risks and rewards of the investment, determine the pricing and structure of the offering, and assist in the distribution of the securities to investors. Their role is crucial in providing confidence and transparency to both issuers and investors.
| 3. What are the key responsibilities of underwriters in investment banking? | |
Ans. Underwriters in investment banking have several key responsibilities, including assessing the financial risks associated with an investment, determining the appropriate pricing and quantity of securities to be offered, conducting due diligence on the issuer, managing the underwriting process, and ensuring compliance with regulatory requirements. They also play a vital role in managing investor relations and marketing the securities to potential investors.
| 4. What are the benefits of underwriting for issuers and investors? | |
Ans. Underwriting provides several benefits for both issuers and investors. For issuers, it helps in raising capital for their projects or business expansion, provides expertise in structuring the offering, and enhances their credibility in the market. It also reduces the risks associated with the offering by sharing the risks with underwriters and investors. For investors, underwriting provides an opportunity to invest in securities that have been thoroughly evaluated and vetted by professionals, offering a certain level of assurance and reducing the risks associated with the investment.
| 5. How does underwriting contribute to the stability and efficiency of financial markets? | |
Ans. Underwriting contributes to the stability and efficiency of financial markets by ensuring proper risk management, maintaining investor confidence, and facilitating the flow of capital. Through their expertise and due diligence, underwriters help to identify and mitigate potential risks associated with investments. This enhances market transparency and reduces information asymmetry. Additionally, underwriting helps to allocate capital efficiently by connecting issuers and investors, thereby promoting economic growth and development.
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