Underwriter
Underwriter is a large financial institution, such as a bank, insurance company and an investment house that guarantees payment in case of damage or financial loss and accepts the financial risk for liability arising from such guarantee.
Underwriters play an integral role in distributing risk in financial markets, thus improving the efficiency of industries such as the mortgage industry, the insurance industry, equity markets, and some common types of debt security trading.
One of the most common instances of underwriting takes place during Initial Public Offerings (IPOs). In this case an investment bank guarantees a price for the company’s securities, which it then pays to the company. In exchange for this sum, the investment bank obtains all of the announced shares and sells them to the open market, cashing in the difference between the price it paid per share and the price per share the market is willing to pay during the IPO.
This example also reveals the main risks of the process, namely, if the market believes that the market price should be lower than that estimated by the investment bank, it suffers huge losses.
The typical duties of an underwriter include:
- Determining the riskiness of an asset
- Determining the price at which a security ought to be sold
- Filing documents requested by financial institutions on behalf of the companies.
