Underwriting is the process of agreeing to take on a risk.
The term underwriting is commonly used in relation to insurance companies. But also is a main part of the process of a company going public.
In the insurance industry, underwriting refers to the process of analyzing risk and then granting coverage in exchange for premiums. Underwriting a policy means the company is agreeing to pay up when the policy-holder is injured or her house floods, or whatever the policy covers happens.
Bringing an initial public offering to the market involves selling shares of the company to the public. Someone has to underwrite this process and take on the risk of a flopping IPO that no one wants to buy. Typically, an investment bank or a consortium of banks will take on the complexities and risks associated with bringing a newly public company's shares to market. So, for instance, the bank will buy the shares from the company for $4 each and then take them to the market hoping to sell them for more than $4 each. But it might get less than $4 and lose money on the underwriting.
The underwriting of IPOs is often undertaken by a group of banks (a syndicate) in order to spread around risk. There will be a lead underwriter. This "manager" can go into the open market during the offering and "stabilize" the price of the stock by bidding for and buying shares. This so-called pegging of the price is legal in this instance, but generally illegal in securities trading.
Related Fool Articles
- [link link title]
Recent Mentions on Fool.com
- Why the Infiniti Q50 Eau Rouge Is a Monster and Infiniti Needs to Build It
- Is This the Start of the Nuclear Renaissance?
- Government Money Meant to Save Houses Is Being Used to Destroy Them
- Is the Government Lying About the Housing Recovery?
- Wal-Mart and Food Delivery: Quietly Preparing for Success
- Target: Opportunity or Still in the Cellar?