A:

There are two main types of underwriting: insurance and investment. Insurance underwriters guarantee to service the obligations of the policies they sell. Investment underwriters buy blocks of stock that they plan to sell quickly, and for a profit, to investors. Both types involve the assessment and management of risk.

Insurance underwriters use actuaries who examine the statistical probabilities of different events. The underwriters use this data to determine whether or not to issue policies as well as to set the premiums. If these estimates turn out to be inaccurate, underwriters can face liabilities well in excess of premiums they have collected.

One prominent example of an insurance underwriter failing to properly asses liabilities occurred during the 2008 financial crisis. American International Group (AIG) had sold credit default swaps totalling $450 billion that insured mortgage-backed securities. These securities were much riskier than AIG had anticipated and the firm had not collected nearly enough in premiums to cover the liabilities it was exposed to. The Federal Reserve and the Treasury Department had to loan AIG $150 billion to keep the company solvent.

Investment underwriters help companies go public, complete secondary offerings and sell debt. Investment bankers research potential markets for stock or debt and calculate how much they believe they can sell and at what price. These underwriters then buy blocks of stock or debt and sell them in smaller amounts to investors. If they buy more stock than is sold at a given price, they are forced to either hold on to an inventory of stock or liquidate it at a lower price. Investment underwriters lose money if the amount raised selling stock is less than the amount they paid for it plus overhead costs.

The initial public offering of Weibo in April of 2014 presented just such a scenario. The IPO was underwritten by Goldman Sachs and Credit Suisse. Originally Weibo and the underwriters had hoped to sell 20 million shares, but on the first day of trading only 16.8 million shares were sold. This left the underwriters holding 54 million of stock.

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