What is a firm commitment in investment banking?

A firm commitment in investment banking refers specifically to a pledge by the underwriter to buy all offered securities from the issuer. This means that the underwriter guarantees the total amount of the offering and assumes the full financial responsibility for the unsold portions of the securities. This arrangement provides issuers with a sense of certainty, as they know that they will receive the proceeds from the sale irrespective of the demand from other investors.

In this context, the underwriter purchases the entire offering and then resells the securities to the public or institutional investors. This practice mitigates the risk for the issuing company, as they are assured of securing capital upfront without the concern of how much of the offering will be sold in the market. The underwriter, while taking on some risk, has the opportunity to earn a profit through the distribution of the securities.

Understanding this concept is crucial as it highlights the role of investment banks in facilitating capital markets and risk management for both issuers and investors.