Definition
Underwriters are specialized financial entities, often investment banks, who assess the risk and pricing of a company’s initial public offerings (IPOs) or securities, ensuring the viabilty of the investment market through guaranteeing the sale of these securities. Market Makers, on the other hand, ensure the liquidity of the market by buying and selling a specific set of securities at their own risk, effectively setting the market price and standing ready to trade at all times. Both Underwriters and Market Makers play integral roles in securities trading, helping maintain a healthy, efficient, and stable marketplace.
Key Takeaways
- Underwriters and Market Makers both play crucial roles in the stock market. Underwriters help companies price their offerings and sell their shares to the public for the first time, primarily during the Initial Public Offering (IPO). On the other side, Market Makers ensure liquidity in the market by constantly buying and selling shares of stocks.
- While underwriters take financial risks by purchasing shares from companies and then selling them to the public, their role typically ceases post-IPO. Market Makers, however, continually take on risks by owning a position in a security to facilitate trading.
- The purpose of both roles is to ensure market efficiency. Underwriters primarily serve to bridge the gap between businesses that want to issue securities and investors who want to buy them. Market Makers, on the other hand, maintain fair and orderly markets by providing liquidity, narrowing the bid-ask spreads, and supporting price continuity.
Importance
Underwriters and Market Makers are two crucial elements in the finance world as they ensure efficiency and fluidity in securities markets.
Underwriters, usually investment banks, play a significant part in the issuance of new securities by purchasing them from the issuer and selling them to the public, mitigating risks related to fluctuating market prices.
They ensure that the issuing companies raise the necessary capital by determining the initial price and attracting investors.
On the other hand, Market Makers help maintain a stable and liquid market by continuously offering to buy and sell securities at publicly quoted prices, ensuring that these securities can be bought or sold at any time.
Their role is vital in facilitating trading activities, controlling price volatility, and enhancing investor confidence in the fair and efficient operation of markets.
Explanation
Underwriters and Market Makers serve vital functions in the financial markets, providing considerably needed liquidity and enabling the smooth operation of markets. Underwriters are typically finance professionals (often investment banks) that assume the risk for a certain issue of securities, such as stocks or bonds, from the issuing body to distribute it in the market.
The fundamental purpose of underwriters is to evaluate the inherent risks and establish a fair price for a security in its initial offering process. They play a crucial role in drumming up interest among potential investors, ensuring that securities are esteemed accurately, and are sold to maintain the stability of the markets.
On the other hand, Market Makers serve a different, yet equally essential, purpose in the financial markets. They facilitate the buying and selling of securities by “making a market.” This means they stand ready to buy or sell a security at publicly quoted prices, ensuring enough volume for transactions to proceed smoothly, hence aiding overall market liquidity.
This role extensively bolsters market performance because it gives assurance to shareholders that they can promptly sell off their holdings whenever they want without causing a notable impact on the price. Both roles are essential cogs in the financial system, working in tandem to ensure stability, liquidity, and accessibility.
Examples of Underwriters and Market Makers
Goldman Sachs & Facebook’s IPO: Goldman Sachs is a renowned investment bank that has underwritten several IPOs. One notable example is Facebook’s IPO in
Goldman Sachs, along with other banks, assessed the potential market for Facebook stocks, determined the initial share price, purchased the shares from Facebook, and then sold them to the public, bearing the risk if the shares do not sell at the hoped-for price.
JP Morgan & General Motors’ IPO: In 2010, General Motors (GM), after recovering from bankruptcy, went public again with what was then the largest Initial Public Offering (IPO) in history. Underwriter JP Morgan, alongside Morgan Stanley, helped GM in the process, buying the shares from GM and selling them to the public. This allowed GM to raise capital and reestablish itself in the market.
Citadel Securities: Citadel Securities is one of the biggest market makers in the world. Every day, they create a market for buyers and sellers by quoting buy and sell prices for securities in numerous global exchanges. This role ensures liquidity and stability in the market. One prime example of Citadel Securities playing the role of a market maker was during the volatility caused by the GameStop stock surge in early 2021 when Citadel stepped in to facilitate trades and maintain market balance.
FAQs about Underwriters and Market Makers
What is an Underwriter?
An underwriter is a person or entity that assesses and assumes another person’s risk for a fee, such as a commission, premium, spread, or interest.
What is the role of an Underwriter in finance?
In the financial world, underwriters facilitate the issuance and distribution of securities from a corporation or other issuing body. Underwriters work closely with the issuer and regulatory bodies to price these securities in an attempt to raise the maximum amount of funds.
Who are Market Makers?
Market makers are individuals or banks that buy and sell large quantities of securities and other assets at prices displayed in an exchange’s trading system for their own account.
What is the responsibility of Market Makers in finance?
Market makers have a key role in financial markets by providing liquidity to facilitate market efficiency and functioning. They essentially ‘make a market’ by quoting prices to both buy and sell a security or other assets, thereby providing a trading platform.
What’s the difference between a Market Maker and an Underwriter?
A market maker provides a platform for foreign currency exchange for the customer whereas an underwriter is a person who assesses and undertakes another person’s risk for a fee. In terms of function in the financial markets, underwriters help new securities to come to market while market makers provide liquidity and efficiency to the market.
Related Entrepreneurship Terms
- Initial Public Offering (IPO)
- Prospectus
- Securities and Exchange Commission (SEC)
- Secondary Market
- Risk Evaluation
Sources for More Information
- Investopedia: An extensive online resource focused on investing and finance, where you can find detailed articles explaining the roles of underwriters and market makers.
- Reuters: A globally recognized news organization, providing up-to-date articles and discussions on finance and related subjects, including underwriting and market making.
- Bloomberg: A major platform offering financial, data and media services worldwide. Both terms can be explored in depth.
- MarketWatch: A financial information website providing business news, analysis, and stock market data, where you can read more about underwriters and market makers with real market examples.
