IMPORTANCE OF UNDERWRITING, PAYMENT TYPES OF

UNDERWRITING

INTRODUCTION

Underwriting is a good technique of marketing the securities. The importance of

under-writing can be adjudged by the following advantages

(i) Assurance of Adequate Finance.

Underwriting is a guarantee given buy the underwriters to take up the whole issue or
remaining shares, not subscribed by public. In the absence an underwriting agreement, a
company may face a situation where even minimum subscription is not received and, it will
have to go, into liquidation. In case of an existing company, it may have to postpone its
projects for which the issue was meant. As a result of an underwriting contract, a company
has not to wait till the shares have been subscribed before entering into the required contracts
for purchase of fixed assets etc. it can go ahead with its plan confidently. Thus, underwriting
agreement assures of the required funds within a reasonable or agreed time.

(ii) Benefit of Expert Advice.

An incidental advantage of underwriting is that the issuing company gets the benefit
of expert advice. An underwriter of repute would go into the soundness of the plan put
forward by the company before entering into an agreement and suggest changes wherever
necessary, enabling the company to avid certain pitfalls.

(iii) Increase in Goodwill of the Company.

The good underwriters being men or firms of financial integrity an established

reputation. As we have already explained that underwriters satisfy themselves with the
financial integrity of the company and viability of the plan, the investors therefore, runs much
less risk when they buy shares or debentures which have been underwritten by them. They
assure of the soundness of eh company. Thus, good underwriters increase the goodwill of the
company.

1
(iv) Geographical Dispersion of Securities.

Generally, underwriters maintain working arrangement wit other underwriters and

broken throughout the country and in other countries too and as such, they are able to tap the
financial resources for the company not only in on particular area but also in other areas as
well. In this way marketability of securities increases and geographical dispersion of shares
and debentures in promoted.

(v) Service to Prospective Buyers.

Underwriters render useful services to the perspective buyers of securities by giving

them expert advice regarding the safe investment in sound companies. Sometimes they
publish information and their expert opinion in respect of various companies. Thus, they
render useful services to the buyers of securities too. The underwriting process determines
how much premium, or money, an insurance company should charge for that policy.

The Underwriting Process or Insurance Cycle

Simply stated, underwriting is the process of insuring someone or

something. Insurance Underwriters are qualified persons who evaluate an insurance proposal
to assess the kind and degree of risk involved.

The Underwriting Process or Insurance Cycle

The underwriting process determines how much premium, or money, an insurance

company should charge for that policy. Underwriters balance the losses insurance carriers
may derive from your potential risk of potential claims.

2
 Premiums, based on rates filed in your state, also reflect personal claims experience
of, and the risk of incurring future claims based upon, that risk.

IMPORTANCE OF UNDERWRITING

Many people feel helpless in this process. That is not true! For example, underwriting
considers:
Claims Experience

If your claims experience is low, your premiums can be low. Underwriters frown on
applicants with many frequent small claims. When possible, take higher deductibles on your
auto and home insurance and pay small claims yourself.

Credit Rating

Credit score is a factor in underwriting. A history of paying your bills on time means
lower premiums!

Type of Vehicle

It is less expensive to insure a mid-sized sedan than a turbo-charged convertible.

Driving Record

A clean driving record and attendance at a defensive driving class makes you a better
risk.

PAYMENT TYPES OF UNDERWRITING COMMITMENTS

Firm Commitment

In a firm commitment underwriting, the underwriter guarantees to purchase all of the

securities being offered for sale by the issuer regardless of whether or not they can sell them
to investors. A firm commitment underwriting agreement is the most desirable for the issuer
because it guarantees them all of their money right away. The more in demand the offering is,
the more likely it is that it will be done on a firm commitment basis. In a firm commitment,
the underwriter puts their own money at risk if they cant sell the securities to investors.

3
Market Out Clause

An underwriter offering securities for an issuer on a firm commitment basis is

assuming a substantial amount of risk. As a result the underwriter will insist on having a
market out clause in the underwriting agreement. A market out clause would free the
underwriter from their obligation to purchase all of the securities in the event of a
development that impairs the quality of the securities or that adversely affects the issuer. Poor
market conditions are not a reason to invoke the market out clause. An example of when an
underwriter could invoke the market out clause would be if the issuer was a bio tech company
and the FDA just denied approval of the company's new drug.

Best Efforts

In a best efforts underwriting, the underwriters will do their best to sell all of the
securities that are being offered by the issuer, but in no way is the underwriter obligated to
purchase the securities for their own account. The lower the demand for an issue, the greater
likelihood that it will be done on a best efforts basis. Any shares or bonds in a best efforts
underwriting that have not been sold will be returned to the issuer.

Mini-Maxi

A mini-maxi is a type of best efforts underwriting that does not become effective until
a minimum amount of the securities have been sold. Once the minimum has been met, the
underwriter may then sell the securities up to the maximum amount specified under the terms
of the offering. All funds collected from investors will be held in escrow until the
underwriting is completed. If the minimum amount of securities specified by the offering
cannot be reached, the offering will be canceled and the investors funds that were collected
will be returned to them.

All or None / AON

With an all or none underwriting, the issuer has determined that it must receive the
proceeds from the sale of all of the securities. Investors funds are held in escrow until all of
the securities are sold. If all of the securities are sold, the proceeds will be released to the
issuer. If all of the securities are not sold, the issue is canceled and the investors funds will
be returned to them.

4
Standby

A standby underwriting agreement will be used in conjunction with a preemptive

rights offering. All standby underwritings are done on a firm commitment basis. The standby
underwriter agrees to purchase any shares that current shareholders do not purchase. The
standby underwriter will then resell the securities to the public.

REFERENCES

http://www.freemba.in/articlesread.php?artcode=463&stcode=10&substcode=28
http://insurancedeals4u.com/Blog/tabid/85/ArticleID/26/What-is-Insurance-
Underwriting-and-Why-is-it-Important.aspx
http://www.investopedia.com/study-guide/series-62/issuing-corporate-
securities/types-underwriting-commitments/