Generally,
underwriting means receiving payment for the willingness to cover a
potential contingent risk. Underwriting is frequently done in
investment banking, insurance and commercial banking.
In
investment banking, underwriting is the practice by which investment
bankers represent corporate and government entities in the initial
public offering of their securities. The investment
bankers
cover the risk of selling the securities
to
the
public. Bankers guarantee to the issuers that the securities will be
sold for no less than a minimum price set by the investment
banker. If the investment bankers can’t find enough purchasers
to buy the securities at the minimum price, the investment bankers
must hold those securities on their books, or worse, sell them below
the minimum price and suffer a loss. Conversely, if there is strong
demand for the securities, the investment bankers make a profit by
selling the securities above the minimum price they promised the
issuer.
In the insurance industry, underwriting is the process
of agreeing to bear the financial risk inherent in an insurance
contract. The insurance underwriters assess the risk that is being
insured, for instance, fire damage to a house. The underwriters
receive the insurance premium from the homeowner and in return, the
underwriters agree to provide compensation for damages that result
from a fire.
In commercial banking, underwriting means assessing the
credit worthiness of borrowers and agreeing to fund loans. The risk
is that the borrower will default on the loan and thus fail to repay
the amount borrowed. The fee for underwriting this risk is typically
periodic interest charged to the borrower as long as there is a
balance due on the loan.
Merits of underlying of Shares and
Debentures:
It fulfills requirement of minimum subscription.
The company is sure of getting the value of shares
issues
It enhances goodwill of the company
It facilitates wide distribution of securitie
Issuing company gets expert advice from underwriters in
the matter of marketing securities
