Underwriting may be defined as the process used by a large financial service provider in order to assess the eligibility of a customer to receive their products. Alternatively, it is the process for raising capital for corporations or government in form of issue of securities by investment bankers.
The word ‘underwriter’ refers to the person willing to take the certain risk and sign under the amount of risk he or she is willing to accept at a specified premium.
Underwriting in different fields
Underwriting is widely applicable, but it’s most often used in investment banking, insurance and commercial banking.
- In investment banking, underwriting refers to investment bankers representing corporate and government entities in the initial public offering of their securities.
- In the insurance industry, it means agreeing to bear the financial risk inherent in an insurance contract.
- In commercial banking, underwriting refers to assessing the credit worthiness of borrowers and agreeing to fund loans.
Some of the other forms of underwriting are real estate underwriting, forensic underwriting, sponsorship underwriting etc.
Underwriting contract represents a contract agreement to be signed by an underwriter and an issuer of securities. Some of the most frequently used types of underwriting contracts are:
- Firm commitment contract: in such type of the contract the underwriter provides a guarantee for sale of the issued stock at the price defined prior to the issue.
- Best efforts contract: in this type of contract the underwriter provides an agreement to sell as many stocks as possible at the price defined in advance.
- All-or-none contract: within such contract, the underwriter explains the agreement either to sell the entire offering or to cancel the deal.
It is clear that the underwriting is a great technique for marketing the securities. Its importance will be shown through its main advantages:
- Adequate finance will be assured – as underwriting agreement affirms the required funds by the end of agreed time period.
- Expert advice will be a benefit – the issuing company obtains expert advices from the underwriter and benefits from them.
- Goodwill of the company will be increased – good underwriters are individuals or companies of financial integrity and established reputation, so by building and accompanying the underwriting process they will increase the goodwill of the company.
- Securities to be issued will be geographically dispersed – underwriters make geographical borders disappear, since they can assemble on the arrangement with other underwriters within and outside of the country, which increases marketability of securities.
- Prospective buyers can benefit from service of underwriters – underwriters provide several services and expert advices about investments to the potential buyers of stocks.