An investment bank may take a big loss when underwriting an issue on a firm commitment basis because

Question

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When an investment bank underwrites an issue on a firm commitment basis, it guarantees to purchase all of the shares of the offering at a fixed price and then resell them to the public. If the investment bank overestimates the demand for the shares, it may end up holding onto unsold shares, which will lead to a loss. Underestimating the demand may lead to the bank underpricing the shares and missing out on potential profits. However, interest rates and security prices may also affect the success of the offering, but they are not directly related to the investment bank's underwriting process.

An Investment Bank May Take a Big Loss When Underwriting