Legal Definitions - spread

The term "spread" has several distinct meanings within finance, generally referring to a difference between two prices or rates.

• 1. In Banking: The Interest Rate Difference

  This refers to the difference between the interest rate a bank pays to its depositors (for savings accounts, certificates of deposit, etc.) and the higher interest rate it charges borrowers for loans (like mortgages, car loans, or business loans). This difference represents the bank's primary profit margin on its lending activities.

  • Example 1: Mortgage Lending

    A local bank offers savings accounts that pay 0.75% interest to its customers. At the same time, it charges 4.5% interest on its 30-year fixed-rate mortgages. The "spread" in this scenario is 3.75% (4.5% - 0.75%), which is how the bank generates revenue from its lending operations.

  • Example 2: Business Loans

    A credit union pays 1% interest on its business checking accounts. It then lends money to small businesses at an interest rate of 6%. The 5% difference (6% - 1%) is the spread, covering the credit union's operational costs and profit.

• 2. In Securities Trading: The Bid-Ask Difference

  This is the difference between the highest price a buyer is willing to pay for a security (the "bid" price) and the lowest price a seller is willing to accept for that same security (the "ask" or "offer" price). This spread represents the cost of immediate liquidity in the market and is often a source of profit for market makers who facilitate trades.

  • Example 1: Stock Trading

    An investor wants to buy shares of "Company X." The highest price anyone is currently willing to pay for Company X's stock is $50.00 (the bid price), while the lowest price anyone is willing to sell it for is $50.05 (the ask price). The "spread" is $0.05 per share, reflecting the immediate cost to buy or sell the stock.

  • Example 2: Foreign Exchange

    When converting currency, a bank might offer to buy Euros from you at an exchange rate of 1.08 US dollars per Euro (the bid) and sell Euros to you at 1.10 US dollars per Euro (the ask). The "spread" of $0.02 per Euro is the bank's profit margin on the currency exchange.

• 3. In Securities Trading: An Options or Futures Strategy

  This refers to an investment strategy where an investor simultaneously buys and sells two or more related options or futures contracts on the same underlying asset, but with different strike prices, expiration dates, or both. The goal is to profit from the difference in their prices or to limit risk.

  • Example 1: Call Option Spread

    An investor believes a stock will rise moderately. They might buy a call option with a strike price of $100 and simultaneously sell another call option on the same stock with a strike price of $105, both expiring in the same month. This combination is a "call spread," designed to profit if the stock price stays within a certain range, while also limiting potential losses compared to just buying a single call option.

  • Example 2: Futures Spread

    A commodities trader might buy a futures contract for crude oil expiring in March and simultaneously sell a futures contract for crude oil expiring in June. This "futures spread" aims to profit from the expected difference in prices between the two delivery months, rather than betting on the outright price movement of crude oil itself.

• 4. In Investment Banking: The Underwriting Fee

  In the context of an initial public offering (IPO) or a new bond issuance, this is the difference between the price an investment bank (the underwriter) pays to the company or government issuing the securities and the higher price at which the investment bank sells those securities to the public. This "underwriting spread" compensates the investment bank for its services, including advising, marketing, and taking on the risk of selling the securities.

  • Example 1: Initial Public Offering (IPO)

    A new software company decides to go public. An investment bank agrees to buy shares from the company at $19.00 per share and then sells those shares to the public at $20.00 per share. The $1.00 difference per share is the "underwriting spread," which is the fee the investment bank earns for managing the IPO.

  • Example 2: Corporate Bond Issuance

    A large corporation issues new bonds to raise capital. An investment bank purchases these bonds from the corporation at $995 per bond and then offers them to institutional investors at $1,000 per bond. The $5 difference per bond is the "underwriting spread," compensating the bank for its role in facilitating the bond sale.