Final answer:
Under a full-underwriting arrangement, investment banks assume market risk, credit default swap risk, and significant financial loss if securities are unsold or sold at a discount. Subprime loans packaged into CDOs and backed by NINJA loans heighten this risk.
Step-by-step explanation:
Under a full-underwriting arrangement, the investment bank or syndicate purchasing the entire issue assumes significant risks. The primary risk is that the securities may not be sold at the forecasted price, which can mean the underwriters may have to sell them at a discount, incurring a financial loss. This situation arises from market conditions, the issuer's performance, or wider economic factors.
In addition to market risk, they also bear the risk of credit default swaps, a kind of insurance that pays out if investments decline in value. The complex structuring of these financial instruments includes tranches, where different investors bear varying degrees of loss. However, if subprime loans packaged into collateralized debt obligations (CDOs) decline significantly in value, the underwriters may still face substantial losses, especially if they have retained some of the riskier portions of the securities.
The experience during the mid-2000s financial crisis illustrated how the securitization of subprime loans could lead to sizable losses for financial institutions, particularly when these loans were made without thorough checks on borrowers' ability to pay, resulting in NINJA loans.