How do I peer respond and ask a question:

Class,

This week I decided to focus on Chapter 19 and the section discussing underwriters. In particular, I focused mainly on the difference between Firm Commitment Underwriting and Best Efforts Underwriting.

Firm Commitment Underwriting is where the issuer sells the entire issue to the underwriter. Basically it is a purchase-resale agreement. Underwriters look at the market price to determine what the issue should sell for, and most issues are sold at firm commitments. This method puts the majority of the risk on the underwriter, with the issuer receiving the agreed upon amount. Because the offering price usually isn't set until the underwriters have investigated how receptive the market is to the issue, the risk is usually minimal. Also, because the offering price usually is not set until just before selling commences, the issuer doesn't know precisely what its net proceeds will be until that time (Ross et al., 2015).

Best Efforts underwriting is when the underwriter sells the securities at the agreed-upon offering price. This method doesn't guarantee any particular amount of money to the issuer. This method has been less popular in recent years, with the method above being the preferred method.

Best Efforts vs. Firm Commitment

Underwriters and issuers can handle public offerings in different ways. In contrast to a best-efforts agreement, a bought deal, also known as a firm commitment, requires the underwriter to purchase the entire offering of shares. The underwriter's profit is based on how many shares or bonds it sells, and on the spread between their discounted purchase price and the price at which they sold the shares (Chen, 2019).

References:

Chen, J. (2019, October 3).Best efforts: Underwriting definition with example. Investopedia. https://www.investopedia.com/terms/b/bestefforts.asp

Ross, S. A., Westerfield, R., Jaffe, J. F., & Jordan, B. D. (2015). Corporate finance: Core principles and applications. McGraw-Hill Education.