Understanding Underwriting: An Investment Banking Essential

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Underwriting is the process through which an investment bank raises capital for a client, typically a corporation, by issuing debt or equity securities. Acting as an intermediary, the investment bank negotiates terms, manages the capital-raising process, and ensures the smooth issuance of securities.

Types of Underwriting Transactions

Investment banks play a crucial role as intermediaries between companies seeking to issue new securities and the public. The two primary types of securities they help clients raise are equity and debt securities.



Equity Securities Underwriting:

A corporation raises capital by issuing shares, representing partial ownership in its equity, to the public.
The first issuance of shares by a private company to the public is called an initial public offering (IPO).
Debt Securities Underwriting:

A corporation raises capital by issuing debt securities, which are obligations to pay periodic interest and repay the principal at maturity.

Examples include commercial paper (CP) and corporate bond issuances.

The Role of an Investment Bank in Underwriting

Investment banks underwrite both stocks and bonds through IPOs and subsequent secondary offerings. They ensure that institutional investors, such as mutual funds and pension funds, commit to purchasing the securities before they hit the market. This intermediary role involves:

  • Buying the new securities issue from the issuing company at a negotiated price.
  • Promoting and reselling the securities to institutional investors and the public.
  • Forming a syndicate of banks to spread risk and handle large issuances.
  • Facilitating trading by buying and selling securities from their own accounts, profiting from the bid-ask spread.

The Underwriting Process

Selection of Investment Bank:

The corporation hires an investment bank or a group of banks to start the underwriting process.

Due Diligence and Risk Analysis:

The bank examines the risks and performs in-depth due diligence to ensure the accuracy and transparency of the issuer's financial data, adhering to SEC regulations.

Creating Marketing Material and Deliverables:

The bank analyzes the business model, market positioning, and industry trends to create compelling presentations for investors.

Preparing SEC Filings and Pricing Securities:

After due diligence, the bank structures the deal, determining the type, volume, and price range of the securities. They estimate the offer price to balance high valuation for the client and successful sale of all securities.

Underwriting Type:

In firm commitment underwriting, the bank agrees to purchase the entire issuance at a predetermined price, bearing substantial risk.

Marketing Phase ("Roadshow"):

The bank markets the securities to institutional investors, prepares the prospectus, and seeks regulatory approval from the SEC.

Sale and Distribution of Securities:

Upon concluding the marketing phase, the bank issues the securities to institutional investors, followed by public trading.

Stabilization of Issued Securities:

Post-issuance, the bank monitors the securities' performance and may stabilize the price through market making, ensuring liquidity and reducing volatility.

Example of Underwriting in Investment Banking

Consider Gillette, which wants to raise funds for a new project. One method is issuing more stock via a secondary offering. Gillette approaches JPMorgan, which prices the new shares based on Gillette's valuation and market conditions. JPMorgan underwrites the offering, guaranteeing Gillette a specific amount of proceeds minus fees.

JPMorgan then utilizes its sales force to sell the shares to institutional investors like Fidelity. The firm's traders facilitate the buying and selling of these shares, creating a market for the offering and ensuring liquidity.

Underwriting is thus a cornerstone of investment banking, crucial for raising capital and ensuring the smooth issuance and trading of securities.






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