Underwriting in Stock Markets Today
By Phuong Le
The term "underwriting" comes from the historical practice where risk-takers (insurers or bankers) would write their names under a contract, agreeing to take on financial risk in exchange for a fee.
In stock underwriting, an investment bank or institution agrees to buy all or part of a company’s shares before selling them to the public. This ensures that the company raises the money it needs, even if the stock doesn’t sell well.
Why Is It Called Underwriting?
📜 Historical Origin
- In the 17th century, merchants and bankers in London’s Lloyd’s Coffee House would sign their names "under" a ship’s cargo risk details, agreeing to cover potential losses for a fee.
- This practice later applied to insurance, bonds, and stocks, where institutions took on financial risks in exchange for profits.
Underwriting in Stock Markets Today
When a company wants to sell shares in an IPO (Initial Public Offering) or a secondary offering, an underwriter:
✔ Buys the shares at a set price.
✔ Resells them to investors for a profit.
✔ Takes on risk if they cannot sell all the shares.
Example:
- A company wants to raise $100 million by selling stock.
- A bank underwrites the deal by agreeing to buy all the shares at $10 each.
- The bank then sells them to the public at $12 each, making a $2 profit per share.
- If the market doesn’t want the shares, the underwriter may lose money by selling at a lower price.
