The traditional role that is associated with the investment banking firms in the U.S, is the duty to underwrite security. According to Frederick (123), the various entities which carry out the function of issuing securities include; the local and state governments, the US government agencies, supranational entities, corporations, foreign corporations and foreign governments.
The traditional process that is adopted by the U.S government in the issuing of new securities require that, the investment bankers should carry out various functions, the three major functions include; the giving of advise to the issuer on issues of timing and on the terms and conditions relating to the security, the investment bankers are supposed to buy the securities from the issuers, and lastly, the security is supposed to be distributed to the public.
The Function of the Investment Banks
The role of advisory, has made the bankers in the investment institutions to re-design the traditional structure of security so that, the security offered may attract the investors when compared to the traditional instrument. Richard (77-78) observed that, the high interest rates imposed in the US in the 1980s and 1990s, led to an increased rate of borrowing to the issuers. To solve the problem, investment bankers ensured that securities were designed to have the characteristics that were more likable to investors, but not stressful to the issuers. Security structures were also designed for low quality bond issues.
The second function that is carried out by the investment bank is the buying of new securities from the issuer. It is not necessary that the investment bank buys the securities from the issuer, but they may act as distributors or advisers to the issuer of the new securities. Underwriting is the buying of new securities from the issuer. The investment bank may organize to buy the securities for a certain amount of money; such a situation is called a firm commitment. The risk undertaken by the investment bank is such that, it expects to incur fewer expenses while re-offering the security to the public, than the price it pays while buying the security from the issuer. The best arrangements for underwriting would be such that, the investment firm accepts only to offer its expertise in the sale of the securities, but does not buy the entire issue from any of the issuers.
The underwriter discount, or gross spread is the profit realized by the investment firm from the difference between the amounts of buying the issue, to the amount realized when the securities are re-offered to the public. James (43-46) posited that, the initial public offering is the common stock offering, and is offered by companies who have not given such a public offering before, due to the likely risk of pricing and later placing the IPOs at a higher gross spread.
There is so much risk which may arise with regard to the underwritten transactions. This makes the investment banks to come together while underwriting transactions, so as to share the risk of loosing capital. The underwriting syndicate is the group of investment banks who come together and undertake to share the risk of loss.
Where gross spread is realized, it is shared among the lead underwriters, and any other investment firms who participated in the underwriting. The deal is managed by the lead underwriters. Where the lead underwrites are many, they are referred to as the co-lead. Where the offer involves the transaction of a bond, the gross spread customarily received by the lead underwriters is 20% payment for managing the deal (Michael 87).
The gross spread is realized by selling the entire issue of security to the public at the agreed re-offering price. An investor client base is established by the investment firm to help in the sale of the securities at the retail level. A selling group is pulled together by the investors as a way of increasing potential for the investor base. In the US, there is no limitation of the underwriting security to the offerings. The issuers have the freedom to choose from many foreign markets, which one they prefer to use in order to reduce the cost of funds.
It is appropriate and important that the investment banking firms adopt the best policies and strategies to ensure that, the process of issuing securities is effective. The U.S government has established a traditional process which ensures that, the terms of issuing securities are attractive to the investors, and that the investment firms minimizes the risk of loosing capital and makes appropriate gross spread.
Doha, M. (2003). International Regulatory Rivalry in Open Economies: The Impact of Deregulation on the Us and Uk Financial Markets. Published by Ashgate Publishing.
Frederick, P. (2005). The International Journal of Accounting. Published by Springer International. Financial Markets and Institutions. Published by Addison Wesley.
James, M. (2006). United States Securities Law: A Practical Guide. Published by Kluwer Law International.
Michael, S. (2004). The Issue of Securities in the U.S. New York: McGraw Publishers.
Richard, A. (2002). Financing and Risk Management. New York: Published by McGraw-Hill.