What is the role of 'underwriting' in investment banking?

• A. To oversee the compliance of financial regulations
• B. To guarantee a fixed price for the issuer during securities issuance
• C. To evaluate market conditions before issuing stocks
• D. To provide legal advice during mergers and acquisitions

Answer: (B)

Underwriting in investment banking plays a crucial role primarily in the process of issuing new securities. It involves investment banks acting as intermediaries between the issuers of securities (such as companies or governments) and the investors. The key function of underwriting is to guarantee a fixed price for the issuer during securities issuance. This guarantees that the issuer will receive a specific amount of capital, regardless of the market demand for the securities once they are released.

By taking on the risk of paying the issuer that fixed amount, the underwriters essentially absorb the uncertainty associated with selling the newly issued securities. If the demand is high, underwriters may sell the securities at a higher price and profit from the difference; if demand is low, they still fulfill their commitment to the issuer at the agreed-upon price. This function is vital for providing issuers with the confidence to proceed with capital-raising efforts, and it stabilizes the market by helping determine the initial pricing of new issues.

Other roles in investment banking, such as compliance oversight, market evaluation, or providing legal advice, serve important purposes but do not define the core function of underwriting, which is centered around managing financial risk and facilitating the capital-raising process.