Trading and brokerage is an investment banking business line that involves purchasing and selling securities by using the bank’s money or conducting it on behalf of clients. The first type of trading is proprietary trading and the second is brokerage.
In trading the bank makes money when they have purchased a security that appreciates. On the other hand, brokerage relies on earning a markup on the difference between the price at which securities are bought and sold. In theory, the bank should have a quasi-neutral exposition in this case and earn more when higher volumes are sold. These two core activities shape the profitability of many firms on Wall Street. Trading and brokerage account for more than a third of the revenues of investment banks like Morgan Stanley and Goldman Sachs.
This number is diluted for universal banks due to the large amount of interest income they register. Nevertheless, trading is critical for the profitability of both types of banks. Proprietary trading means using a bank’s money to buy securities held for a while and later sold at a profit. Investment banks have a competitive edge when performing this activity because they have a pulse on financial markets and understand what types of trades are likely to be profitable in the short term. Another factor that helps is the research department’s work, which can provide valuable insights.
The research department employs highly specialized strategists who provide well-informed opinions and support a bank’s proprietary trading efforts. Investment banks play a vital role in the liquidity of financial markets. They often support the trading of less liquid securities by applying a market-making technique, buying a certain number of shares, and being ready to sell them to customers. When they place an order. Banks earn a substantial spread to do this service for relatively illiquid security. Due to the price volatility risk involved in holding a financial instrument for a longer time.
Nowadays, investment banks trade many types of securities. Besides the traditional asset classes like equities and fixed income, they tend to be active with instruments like derivatives. Derivative financial instruments are many and vary significantly in their nature. Some are used for hedging purposes by industrial companies to reduce risk, while others serve for speculative reasons. Examples of derivative instruments include forwards, futures, options, and swaps.
