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Question

Difficulty: HardTypes of Markets and Trading Venues

An investor purchases shares of a publicly traded corporation. The executing broker-dealer fills the customer's order directly from its own proprietary inventory and adjusts the price by charging a mark-up on the transaction. In this transaction, in what capacity did the broker-dealer act, and in which market segment did the trade occur?

  1. The firm acted as a dealer (principal) in the secondary market.Answer
  2. B
    The firm acted as a broker (agent) in the primary market.
  3. C
    The firm acted as a broker (agent) in the secondary market.
  4. D
    The firm acted as a clearing depository through the Depository Trust Company (DTC).

Answer

The firm acted as a dealer (principal) in the secondary market.
When a broker-dealer executes a trade directly from its own proprietary inventory, it acts in a principal (dealer) capacity and earns compensation through a mark-up (or mark-down). Because the transaction involves existing, outstanding shares of a publicly traded company being bought and sold between market participants, the transaction takes place in the secondary market.

Step-by-Step Solution

1
Determine the trade execution capacity of the broker-dealer based on the inventory source and compensation type.
Because the firm filled the trade directly from its own proprietary inventory and charged a mark-up, it executed the trade as a principal (dealer).
Dealers act as principals when trading for their own accounts, earning a mark-up (on sales) or mark-down (on purchases). Brokers act as agents matching third parties and charging commissions.
2
Identify the market venue segment based on the nature of the security traded.
The investor purchased existing shares of a publicly traded corporation, placing the trade in the secondary market.
The primary market involves original issuers creating and selling new securities (e.g., IPOs), whereas transactions of already-outstanding securities between investors occur in the secondary market.

Key Concept

Broker (Agency) vs. Dealer (Principal) Roles in Secondary Markets
Estimated Time:1m 30s
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Topics

Types of Markets and Trading Venues

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