Future Business Leaders of America (FBLA) Securities and Investments Practice Test

What describes a firm commitment underwriting?

1. Underwriters sell securities on behalf of the issuer

2. Underwriters act solely as brokers

3. Underwriters purchase all securities and take ownership

4. Underwriters only manage the sale of securities

The correct answer is: Underwriters purchase all securities and take ownership

A firm commitment underwriting is a process where underwriters purchase all the securities being issued by a company and then take ownership of those securities. This approach places the financial risk on the underwriters, as they guarantee the issuer a certain amount of proceeds by agreeing to buy the entire offering. After purchasing the securities, the underwriters then resell them to investors, hoping to earn a profit from the difference between the price paid to the issuer and the price at which they sell the securities to the public. This method provides certainty to the issuer regarding the capital they will receive, making it a popular choice for many companies seeking to raise funds. The inability of the other choices to accurately describe this underwriting method further emphasizes why the correct answer is appropriate. For instance, while some underwriters do sell securities on behalf of the issuer, in a firm commitment underwriting, they actually take responsibility for purchasing the securities themselves rather than merely acting as intermediaries. This distinguishes firm commitment underwriting from options where underwriters act solely as brokers or simply manage the sales process, neither of which involves taking direct ownership and financial risk associated with the securities.