Gross Spread

Definition

In finance, the term “Gross Spread” refers to the fees that underwriters receive for arranging and underwriting an initial public offering (IPO) or a secondary offering of securities. It is basically the difference between the price paid by underwriters to the issuer and the price received from investors or the market. The gross spread is usually measured as a percentage of the gross proceeds from selling the securities.

Phonetic

The phonetic spelling for “Gross Spread” is: /ɡrəʊs sprɛd/

Key Takeaways

<ol> <li>Gross Spread: Gross spread refers to the difference between an underwriter’s buying price and selling price for a security. It’s the complete sum of commission and compensation that underwriters get for marketing and selling securities and this often includes all incomes that an underwriter can make from underwriting transactions.</li> <li>Risk and Profit: The Gross Spread is the only profit and compensation an investment bank (underwriter) gets for the risk and work it undertakes in processing the transaction. This spread compensates the investment bank for the time and risk it takes in purchasing, holding, and selling the securities.</li> <li>Factors affecting Gross Spread: The gross spread can vary widely depending on various factors such as the type of transaction (IPO, secondary offering), the issuer size, and the market conditions. Higher risk offerings usually command larger gross spreads.</li></ol>

Importance

Gross spread is a critical term in business and finance as it indicates the fees or commissions on transactions earned by underwriters who handle public offerings for companies. Often used in the investment banking sector, the term helps measure the profitability of the underwriting business. The gross spread varies based on the risk associated with the security being issued, the size of the issue, and the reputation of the issuing company. By analyzing the gross spread, investment banks can evaluate the profit margin they can expect from undertaking the underwriting process, which influences their willingness to engage with a particular business or offering. Therefore, it plays a pivotal role in shaping strategic decisions within investment banking operations and can directly affect a firm’s profitability.

Explanation

The principal purpose of a gross spread in finance and business is to remunerate investment banks for their underwriting services in public offerings. It is an essential aspect of the initial public offering (IPO) process, acting as the compensation to the investment bank or underwriter for taking on the risk and responsibility involved with selling shares of a company to the public for the first time. This fee covers not only the risk taken, but also the work and expertise required to price and sell the offering accurately.Gross spread is widely used as the industry standard for underwriting fees. It’s a universal measure that enables comparisons between different offerings and investment banks. In addition to covering risk bearing and marketing services, the spread may also cover costs such as due diligence, legal fees and other out-of-pocket expenses. Therefore, it’s an integral part of the monetary exchange between the issuer and the underwriter in securities offerings, ensuring the underwriting process operates efficiently.

Examples

1. Initial Public Offerings (IPO): When a company decides to go public, it often hires an investment bank or banks to underwrite the IPO. The bank buys the shares from the company and sells them to the public. The gross spread in this example is the difference between what the bank pays the company for the shares and what it sells the shares for to the public.2. Bond Issuance: Another example can be seen in bond issuance. If a government or corporation is looking to raise capital, they often do so by issuing bonds. The underwriter here again purchases these bonds and sells them to investors. The difference between the purchase price and the sale price is the gross spread.3. Mortgage Lending: In the context of mortgage lending, the gross spread may refer to the difference between the interest rate charged to the borrower and the interest rate that the financial institution pays to its lenders (or the rate it would earn in an alternative risk-free investment). It’s also often referred to as the net interest margin in banking. This spread represents the financial institution’s profit for rendering this service.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Initial Public Offering (IPO)
• Underwriting
• Capital Markets
• Investment Banking
• Securities

Sources for More Information

• Investopedia
• Corporate Finance Institute
• Wall Street Mojo
• The Free Dictionary – Financial Dictionary