Prime Broker Definition
Quick Definition: Prime Broker | Explaining Prime BrokerageAfter running this blog for several years, I come across many familiar questions so I am putting together a frequently asked questions page to help answer some of these basic hedge fund questions as well as posting the answers here. To start, here is a quick question and answer on what is a prime broker?
Question: What is a prime broker and why is prime brokerage important for hedge funds?
Answer: Prime brokers are one of the most important servicers of the hedge fund industry because they help facilitate the trades that the funds make. Unlike the average investor, hedge funds have much higher daily trading activity and higher trading volume, so while you or your neighbor may buy 10 shares of GE a share, a hedge fund may buy 100,000 shares. Prime brokers help to make this type of large transaction possible and they are rewarded handsomely.
Brokers take a commission on trades and hedge funds trade more and have larger orders than most investors so the commissions are more frequent and larger. Even compared to much larger institutional brokerage clients, hedge funds can generate a higher level of commissions due to their higher trading activity. The prime broker provides a crucial service to the hedge fund client, lending, which can enable ever-larger trades with the use of leverage. This in turn multiplies to possible return (or loss) for the hedge fund. The prime broker's primary role is to hold the fund's assets as its custodian, clear trades, give the fund reports on positions and trading activity and lend for trades. Prime brokers can finance very large leveraged long and short positions for its hedge fund clients, providing the lender (prime broker) with a healthy stream of revenue from its clients (and a level of risk if the fund blows up). A prime broker may also assist in marketing the fund and raising capital for it by way of capital introduction to qualified investors.
These make up the primary functions of a prime broker: financing leveraged positions, capital introductions and marketing, clearing trades, holding onto assets, providing recordkeeping services to funds and other back office services.