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Difficulty: HardTypes of Markets and Trading Venues

When executing a customer order for an unlisted equity security, a market-making firm sells shares directly to the investor out of its proprietary account. In what capacity is the firm operating, and how is its transaction remuneration derived?

  1. The firm is acting in a principal capacity and receives compensation through a markup added to the sale price.Answer
  2. B
    The firm is acting in an agency capacity and receives compensation through a commission for executing the trade.
  3. C
    The firm is acting in a primary market capacity, transferring trade proceeds directly to the issuing corporation.
  4. D
    The firm is acting as a clearing participant, fulfilling continuous net settlement responsibilities on behalf of the NSCC.

Answer

The firm is acting in a principal capacity and receives compensation through a markup added to the sale price.
When a broker-dealer sells securities directly from its proprietary inventory to a customer, it is acting as a principal (dealer). In principal transactions, the firm does not charge a commission; instead, it marks up the price when selling to the customer or marks down the price when buying from the customer.

Step-by-Step Solution

1
Identify the trading capacity based on inventory usage.
Selling out of proprietary inventory indicates a principal (dealer) transaction.
Broker-dealers acting as principals buy and sell for their own account.
2
Determine the corresponding fee/remuneration structure for principal trades.
Principal transactions involve a markup (on sales) or markdown (on purchases).
Commissions are charged only when acting as an agent (broker) matching third parties.

Key Concept

Broker vs. Dealer Roles and Remuneration in Trading Venues
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Topics

Types of Markets and Trading Venues

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