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

Question

Quizplus · Accepted Answer

When an investment bank underwrites an issue on a firm commitment basis, it guarantees to purchase all shares of the issue and then sells them to investors. If the demand for the shares by the market turns out to be lower than anticipated, the investment bank may have to purchase the unsold shares at a higher price than what it sold them for, resulting in a loss. This is why the investment bank may overestimate the demand for the shares by the market.

An Investment Bank May Take a Big Loss When Underwriting