Underwriting Shares Meaning: Since individuals have heard the rags-to-riches story of several renowned Indian investors, most of them are drawn to investing in stock markets today.
Despite increased awareness about Indian stock markets, there are investors lacking the knowledge to brace volatility related to the asset class.
Several investors view the stock market as a ‘get-rich-quick’ scheme. However, others view this as a place where profits can be made when stocks perform well and rise in value.
There are investors in the investing community who prefer to invest only in IPOs. However, before investing in IPOs, due diligence is of utmost importance.
Reasons behind fundraising, understanding the business model, analyzing management and promoter background, etc. are some of the basic checks required to be done by an investor.
While stock market veterans find it easy to understand complex terms, the process can be a little difficult for novice investors. All these factors affect the subscription the IPO is likely to get.
Therefore, new investors are required to have some entity that can take care of the risks. It is advisable to select an IPO which has a strong underwriter.
Underwriting shares meaning will be explained in this article. Apart from this, this article will cover the types of underwriting and why is it so important. Read on!
Underwriting – What Is It?
Underwriting can best be understood after knowing the role of the underwriter in different financial domains. Let us start with underwriters working in the share market i.e. securities underwriting.
Underwriting refers to one of the critical functions in the financial community in which an individual or an institution seeks to undertake the risks associated with an organization, an investment, or a loan in return for a premium.
Nomenclature ‘underwriting’ came from the practice in which risk takers write their name below the total risk they are willing to undertake in return for a specified premium.
In today’s world, underwriting is categorized as one of the main functions in the financial world. In the world of the share market, underwriting refers to determining the risk and price of a particular security.
This process is visible mostly during IPOs, in which investment banks first buy or underwrite securities of the company coming out with an IPO and then sell them in the market.
This process helps in ensuring that the issuers can raise the full amount of capital. Underwriters are eligible to get a premium for this service.
Securities underwriting is of utmost importance as it guarantees that IPO will be able to collect the required capital and give a premium or profit to underwriters for the required services.
This type of underwriting is involved in cases of individual stocks, municipal and government bonds, and debt securities. When a company gets listed, each stakeholder tends to develop certain strategic objectives.
The extent to which such objectives are realized continues to play a critical role in determining the success of an IPO.
There are several measures that can help in determining the success of an IPO such as an increase between the company’s opening and closing prices on a listing day, valuation multiple (which gets derived from its offering price, relative to valuation multiples of its comparable companies), its planned execution, etc.
An underwriter also focuses on minimum subscription. This means a minimum number of shares that a company requires to get out of the entire issue by the closure date.
As per SEBI, every company should see a minimum subscription of 90% of the issued amount on the closure date. The role of the underwriter gets all the appreciation in case the IPO is undersubscribed.
When underwriters are not able to find sufficient investors, they are forced to buy shares that could not be sold to the general public.
Investors tend to benefit a lot from the underwriting process as information offered by an underwriting agency supports them in making wise and informed buying decisions.
An underwriter holding a large chunk of securities of a particular company is more or less a market maker for security. That underwriter provides the core liquidity for the security and improves price stability and distribution.
Also Read: QIP Impact On Share Price? Is QIP Good Or Bad For Investors?
To Sum Up
In underwriting, an underwriter or institution researches evaluates and calculates the amount of risk which is involved in going ahead with the transaction in question.
Several institutions tend to hire underwriters with the view of determining these financial risks and deciding whether a deal is profitable or not.
In shares underwriting, investors tend to benefit from the vetting process and its ability to make a sound investment decision. That’s all for the article on Underwriting Shares Meaning, Definition, And Types, We hope you enjoyed reading it. Happy Investing!
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