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

What is the unique characteristic of a firm commitment underwriting?

1. Underwriters can return unsold shares

2. Underwriters purchase all securities from the issuer

3. Only accredited investors can buy

4. No financial risk is involved

The correct answer is: Underwriters purchase all securities from the issuer

A firm commitment underwriting involves the underwriters purchasing all the securities being offered by the issuer upfront. This means that once the underwriters agree to the offer, they take on the responsibility to buy the total number of shares at a set price and then resell those shares to the public. This arrangement provides certainty for the issuer, as they receive the proceeds from the sale immediately, regardless of whether the underwriters can sell all the shares later. This method contrasts with other types of underwriting, such as best efforts underwriting, where underwriters do not purchase the securities outright and only sell as many as they can, leaving the unsold shares with the issuer. The firm commitment method also involves financial risk for the underwriters because if they cannot sell all the shares at the expected price, they may incur losses on the securities they have purchased. Therefore, the defining characteristic of firm commitment underwriting is the obligation of the underwriters to buy all the securities from the issuer, ensuring that the issuer raises the desired capital without bearing the risk of selling directly to the public.