Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

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What is a characteristic of the firm commitment underwriting method?

The issuer bears most of the risk
The underwriter has no financial risk
The entire issue is sold to the public
The issuer receives funds upfront

The correct answer is: The issuer receives funds upfront

A firm commitment underwriting method is characterized by the underwriter agreeing to purchase the entire issue of securities from the issuer for a specified price, effectively taking on the responsibility to sell those securities to the public. This mechanism ensures that the issuer receives the full amount of funding upfront, as the underwriter pays the issuer before any securities are sold to investors. This arrangement provides the issuer with certainty regarding the funds they will receive, enabling them to proceed with their planned projects without the uncertainty of fluctuating market conditions. In addition, the firm commitment structure places the risk primarily on the underwriter, who is responsible for selling the securities to the public. If the underwriter is unable to sell the entire issue, they bear the financial risk of holding the unsold securities, which is a key element distinguishing this method from others like best efforts underwriting, where the issuer might not receive any funds if the entire issue isn’t sold.