When the investment banker bears the risk of not being able to sell a new security at the established price, this is known as:
- a best efforts offering.
- Underwriting
- shelf registration.
- making a market.
Answer: b. Underwriting
Answer Explanation
Underwriting is the correct answer when the investment banker assumes the risk of not being able to sell a new security at the established price. In the underwriting process, an investment bank or underwriter agrees to purchase a new issue of securities from an issuing company and then resells those securities to investors or the public.
The investment banker assumes the risk of not being able to sell the new securities at the established price during the underwriting process. As a consequence, if the demand for the securities is lower than expected, investment bankers may end up with unsold shares, resulting in a loss.
Companies commonly raise capital through initial public offerings (IPOs) and other types of public offerings through underwriting. As well as assisting the issuer in determining the offering price, the underwriter coordinates the sale of the securities and acts as a facilitator between the issuer and investors.
Why the other options are not correct
a. Best efforts offering:
This type of underwriting does not require the investment banker to purchase the new securities from the issuer. Rather than assume the underwriting risk, the investment banker uses its best efforts to sell the securities to investors. The issuer, not the investment banker, assumes the risk of not being able to sell the securities at the established price in a best efforts offering.
c. Self registration:
As part of shelf registration, a company registers new securities issues in advance with the securities regulatory authority without immediately releasing the securities. A shelf registration does not involve the investment banker taking on the risk of being unable to sell the securities at a particular price. The securities can then be sold when market conditions are favorable.
d. Making a market
In order to make a market, a brokerage firm or market maker quotes a bid and ask price for a specific security and is willing to buy and sell that security at those prices. Making a market is a secondary market function that facilitates trading and provides liquidity. The investment banker does not have to bear the risk of selling new securities at a fixed price when making a market.
Conclusion
It is known as underwriting when an investment banker bears the risk of not being able to sell a security at the established price. In public offerings, underwriting is a common method for companies to raise capital, and investment bankers are responsible for selling the securities to investors.
The other options (a) Best efforts offering, (c) Shelf registration, and (d) Making a market are not correct because they do not accurately describe the scenario where the investment banker assumes the risk of selling new securities at a fixed price. For companies and investors involved in raising capital through public offerings, understanding the concept of underwriting is essential.
In a common stock rights offering the subscription price is generally:
I am Bibisha Shiwakoti a final year BBS student from Janapremi College. I have completed my higher secondary education at Kalinchowk Secondary School.
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