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Difficulty: MediumTypes of Markets and Trading Venues

A registered market maker receives a customer market order to buy 500 shares of an exchange-listed equity security. The firm fills the order by selling the shares directly out of its own proprietary inventory account and charges the customer a mark-up. In what capacity is the broker-dealer executing this transaction?

  1. Dealer capacity, acting as a principal in a secondary market tradeAnswer
  2. B
    Broker capacity, acting as an agent in a secondary market trade
  3. C
    Underwriting capacity, distributing new shares in the primary market
  4. D
    Clearing participant capacity, providing depository custody for an ECN trade

Answer

Dealer capacity, acting as a principal in a secondary market trade
When a broker-dealer executes a customer transaction by trading directly out of its own proprietary inventory, it is acting in a dealer (principal) capacity. In principal transactions, the firm is on the opposite side of the trade and charges a mark-up (when selling) or a mark-down (when buying).

Step-by-Step Solution

1
Identify the trading venue context
Trading existing exchange-listed equity shares occurs in the secondary market.
Secondary market trading involves transactions between investors and market participants rather than newly issued securities from an issuer.
2
Determine the firm's execution role based on account type and compensation
The firm traded out of its own inventory (proprietary account) and charged a mark-up.
A broker-dealer acting for its own account is acting as a principal (dealer). Dealers earn profits via mark-ups when selling or mark-downs when buying.

Key Concept

Broker (Agent) vs. Dealer (Principal) Capacity in Secondary Market Transactions
Estimated Time:1m 0s
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Topics

Types of Markets and Trading Venues

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