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When a company wants to issue, say, new bonds to get funds to retire an older bond or to pay for an acquisition or new project, the company hires an investment bank. The investment bank then determines the value and riskiness of the business to price, underwrite, and then sell the new bonds.
An underwriter is any party, usually a member of a financial organization, that evaluates and assumes another party's risk in mortgages, insurance, loans, or investments for a fee, usually in the form of a commission, premium, spread, or interest.
Underwriting is the process by which the lender decides whether an applicant is creditworthy and should receive a loan. An effective underwriting and loan approval process is a key predecessor to favorable portfolio quality, and a main task of the function is to avoid as many undue risks as possible.
In the securities market, underwriting involves determining the risk and price of a particular security. It is a process seen most commonly during initial public offerings, wherein investment banks first buy or underwrite the securities of the issuing entity and then sell them in the market.
For instance, an insurance company uses underwriting to judge applicants for coverage and decide whether to accept or deny their application. Similarly, a mortgage lender relies on underwriting to evaluate a loan application and determine whether to approve or reject a home loan.