Canadian Securities Course (CSC) Level 1 Practice Exam

What distinguishes a best efforts underwriting agreement from a firm commitment (bought deal) underwriting agreement?

1. The dealer in a best efforts acts as an agent, while in a bought deal, the dealer acts in principal

2. A best efforts underwriting agreement involves multiple dealers, unlike a firm commitment agreement

3. There is no difference between the two types of underwriting agreements

4. Firm commitment agreements are exclusively used for government bond issuances

The correct answer is: The dealer in a best efforts acts as an agent, while in a bought deal, the dealer acts in principal

In the context of underwriting agreements, the key distinction lies in the roles and responsibilities of the dealers involved. In a best efforts underwriting agreement, the dealer acts as an agent for the issuer, which means that the dealer does not guarantee that all the securities will be sold. Instead, the dealer makes their best effort to sell as many of the securities as possible, and any unsold securities will remain with the issuer. This approach reduces the financial risk for the dealer and allows for a more flexible arrangement. In contrast, a firm commitment (bought deal) underwriting agreement involves the dealer acting as a principal. Here, the dealer purchases all the securities from the issuer at a set price and is then responsible for selling them to the market. This type of arrangement places the risk of unsold securities on the dealer, as they must absorb any unsold inventory. Thus, the fundamental difference revolves around the roles: the dealer in a best efforts agreement is an agent aiming to sell for the issuer, while in a firm commitment agreement, the dealer takes on the role of a principal, thereby assuming the financial risk. Understanding this distinction is crucial for comprehending how different underwriting arrangements function within the capital markets. The other choices do not accurately depict the key differences