To insure; to sell an issue of stocks and bonds or to guarantee the purchase of unsold stocks and bonds after a public issue.
The word underwrite has two meanings. To issue an insurance policy on the life of a person or on property of another is to underwrite that person or property; hence insurance companies are also referred to as underwriters.
The other meaning refers to the issuing of stocks or bonds by a corporation or a government agency to raise capital. The underwriter is a company, often an investment bank, that agrees to sell the SECURITIES. Under its contract with the corporation, the underwriter agrees to pay for any unsold shares.
An underwriter operates by purchasing all of the new issue of stocks or bonds from the corporation at one price and selling the issue in smaller lots to public investors at a price high enough to cover the expenses associated with the sale and to provide a profit. When making a PUBLIC OFFERING of securities, an underwriter is responsible for setting the offering price. It uses its knowledge of the STOCK MARKET and current interest rates and yields to determine the likely demand for the issue.
Typically, an underwriter does not under-write and distribute a security issue alone but instead organizes a syndicate for the venture. Syndicates are often used when the amount of capital sought by a corporation is much larger than a single underwriter cares to risk. By dividing the underwriting of the securities issue, the risk is spread among the various members of the syndicate. The firm that originates the issue acts as manager of the syndicate.
If an underwriter cannot organize a syndicate large enough to cover the entire issue, it usually will arrange with stock brokerage firms to purchase shares at a reduced price, called a concession. This price reduction provides the brokerage firms with a margin to cover expenses and a small profit upon resale.
A corporation selects an underwriter either through private negotiation of a contract or through competitive bidding. In a bidding process, the corporation sets the terms of the issue and then invites potential underwriters to submit bids. The issue is then sold to the highest bidder.
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