Underwriting Spread

When an investment bank issues stock to the public in the secondary market they do so at some expense to themselves. Therefore, to guarantee them selves a profit they engage in simple arbitrage. That is, they agree to buy securities from an issuer in the primary market, at a predetermined price and then attempt to resell these securities to the public, in the secondary market, at a higher reoffering price.

The difference between these two prices is the gross spread or underwriting spread. Investment banks attempt to sell these securities to their existing client base via an initial public offering (IPO) or to the general public, if the existing investors are not interested.

In today’s global financial markets, these customers could be investors located anywhere in the world and firms must therefore use their marketing skills to resell securities. The size of the gross spread, and thus the profit for the investment bank, depends on several factors, including the number of shares to be issued, the credit worthiness of the original issuer, the perceived risk of the issue, etc.

Underwriting Spread