Underwriting Agreements
Underwriting agreements are contracts between an issuing company and underwriters (usually investment banks or securities firms) that outline the terms and conditions under which the underwriters will help the company issue securities (such as stocks or bonds). In these agreements, the underwriters agree to purchase all or part of the securities to be issued by the company and then resell them to investors. Key elements of an underwriting agreement typically include the underwriters' responsibilities, the price at which the securities will be issued, the underwriters' commission, marketing strategies, and other relevant terms. Underwriting agreements can be categorized into two types: firm commitment and best efforts. In a firm commitment underwriting, the underwriters agree to purchase all unsold securities, assuming the risk of any unsold portions. In a best efforts underwriting, the underwriters agree to sell as much of the securities as possible but do not guarantee the sale of all the securities.
Definition: An underwriting agreement is a contract between an issuing company and an underwriter (usually an investment bank or securities firm) that outlines the terms and conditions under which the underwriter agrees to help the company issue securities (such as stocks or bonds). In this agreement, the underwriter agrees to purchase all or part of the securities to be issued by the company and resell them to investors.
Origin: The origin of underwriting agreements can be traced back to the late 19th and early 20th centuries when financial markets began to mature, and companies started raising funds by issuing securities. As capital markets developed, the role of underwriters became increasingly important, not only helping companies issue securities but also providing marketing and pricing strategies.
Categories and Characteristics: Underwriting agreements are mainly divided into two categories: firm commitment and best efforts. In a firm commitment agreement, the underwriter agrees to purchase all unsold securities, meaning the underwriter assumes a higher risk but may earn a higher commission. In a best efforts agreement, the underwriter only agrees to make their best effort to sell the securities without assuming the risk of unsold securities, which involves less risk but also typically lower commissions.
Specific Cases: 1. A tech company plans to raise funds by issuing stocks and signs a firm commitment agreement. The underwriter agrees to purchase all unsold shares at $10 per share and resell them to investors. Eventually, the underwriter successfully sells all the shares, and the company raises the needed funds. 2. A real estate company opts for a best efforts agreement to issue bonds. The underwriter makes every effort to market and sell these bonds, but the unsold portion is handled by the company itself. Although some bonds remain unsold, the company still raises a portion of the funds through this issuance.
Common Questions: 1. What are the main risks of an underwriting agreement? The main risk of a firm commitment agreement is that the underwriter must assume the risk of unsold securities, while the risk of a best efforts agreement is that the company may not raise the expected total funds. 2. How do underwriters determine the issue price of securities? Underwriters typically determine the issue price based on market demand, the company's financial condition, and industry prospects.
