Question

What’s the difference between a commercial bank and an investment bank? List one example of each and briefly describe its primary function.

What are some important differences between mutual funds, Exchange Traded Funds, and hedge funds? How are they similar? List one example for each.

Answer 1

Commercial banks are the banks that take deposits from depositors, and lend out these funds as loans. The depositors and borrowers could be individuals or firms. They earn profits by paying depositors a lower interest rate and earning a higher rate on loaned funds. An example is US Bancorp. Its primary function is taking deposits, and lending funds.

Investment banks are the banks that assist firms in raising capital and issuing securities. They advise firms, underwrite security issues and earn fees in return. They also earn profits from underwriting activities by buying and selling securities. An example is Goldman Sachs. Its primary function is transaction advisory and underwriting.

The difference between a commercial bank and an investment bank is that commercial banks do not undertake transaction advisory/underwriting activities, and investment banks do not take deposits/loan funds.

Units of mutual funds do not trade on exchanges, but can only be bought from the fund or a fund distributor. However, ETFs are mutual funds whose units trade on exchanges like regular shares. Thus, the price of a mutual fund unit is determined at the end of each day by the fund, but the price of an ETF fluctuates regularly throughout the day. ETFs are therefore a special type of mutual fund. An example of a mutual fund is Fidelity® Select Brokerage&Inv Mgmt Port (FSLBX). An example of an ETF is SPDR S&P 500 trust fund.

Hedge funds are neither mutual funds nor ETFs. They are a special type of fund available only to high net-worth individuals (HNIs) and institutional investors. They are an alternative investment class, and focus on non-conventional and alternative strategies. They involve higher risk and specialized understanding, and are thus not available for individuals. An example is Two Sigma Investments.