PLEASE ONLY FINANCE EXPERT ANSWER THIS QUESTION. THIS MUST BE CORRECT AND PERFEC

Question

PLEASE ONLY FINANCE EXPERT ANSWER THIS QUESTION. THIS MUST BE CORRECT AND PERFECT!!

PLEASE DO NOT COMBINE THE ANSWERS INTO ONE PARAGRAPH, ANSWERS OF A AND B SHOULD BE SEPARATED. DO NOT ANSWER THIS WITH YOUR HANDWRITING, PLEASE TYPE ON YOUR COMPUTER!!

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A. Describe the differences in the underwriting process for an Investment Bank between a firm commitment securities offering and a best efforts offering.

B. What are the risks assumed by the Investment Company and those assumed by the Client for each of these two types of offerings

Explanation / Answer

Answer A)

The differences that exist between firm commitments and best efforts underwriting are so substantial that they can often impact the success of an underwriting, and have an affect on the issuer.

A firm commitment is when a written agreement exists between an investment bank and the issuer of the securities. This agreement outlines the bank’s purchase of the securities from the issue, so that these securities can be offered to the public.

The investment banker serves as the underwriter, and thus is obligated to earn profit from the difference between the purchase price and the public offering price. The purchase price is determined one of two ways:

With a best efforts agreement, investment bankers serve as agents and agree to invest their “best efforts” into selling an issue to the public. Unlike a firm commitment, the bankers (or agents) aren’t buying the securities. Rather, the agents have an option to buy, as well as an authority to sell the securities.

Contracts can vary with best efforts. It is possible for agents to buy up enough shares to cover their sales to clients. On the other hand, they can also cancel the issue that isn’t completely sold, and thus forego the fee.

Because of this, issuers tend to have an increased risk, as well as delays, when it comes to best efforts underwriting. As a result, you’ll typically find best efforts agreements handled by firms with specific experience working with new and young companies.

Another agreement worth understanding is the standby commitment, which involves a corporation (serving as issuer) and an investment-banking firm (serving as the standby underwriter).

In this agreement, the corporation contracts to purchase any portion of a stock issue offered to shareholders in what’s called a rights offering that’s not subscribed to during the standard 2-4 week standby period. A right entitles its holder to purchase a specified amount of shares prior to a public offering, and typically at a lower price than what will be offered to the public.

In the firm commitment underwriting, which is more typical, the investment banker guarantees the issuer a fixed amount of money from the stock. The bank investing purchases the stock from the firm at a fixed price and resells it to the public. The underwriter takes the responsibility of the risk that the resale price might be lower than the price the insurer pays.

In the best-effort underwriting, the investment banking firm does not guarantee to sell the securities at a certain price. The investment banker does not take the responsibility the price risk associated with underwriting the issue, and compensation is based on the amount of shares sold.

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