ACCA Advanced Financial Management (AFM) Practice Exam

What benefit do underwriters gain from underpricing securities?

1. Increased sales commissions

2. Enhanced reputation in the market

3. Greater securities trading volume

4. Lower regulatory scrutiny

The correct answer is: Greater securities trading volume

Underwriters benefit from underpricing securities primarily through the increase in trading volume. When a security is underpriced, it generally leads to strong initial demand which can create a positive market sentiment. This strong demand results in higher trading activity once the securities are listed. An increase in trading volume can lead to enhanced liquidity, attracting more investors and subsequently contributing to a better reputation for the underwriters involved. Additionally, the success seen from a well-received offering, evidenced by strong trading volume, can translate into long-term advantages. This includes an opportunity for future business because satisfied clients may be more likely to engage those underwriters for subsequent capital-raising needs. The other options, while they may have some relevance in specific contexts, do not capture the primary mechanism by which underwriters benefit from the strategy of underpricing. Enhanced reputation in the market and increased sales commissions are indirect results that can stem from improved trading volume, rather than being the primary benefit themselves. Lower regulatory scrutiny is also not directly correlated with underpricing, as regulatory concerns often arise from different factors.