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Question

Difficulty: EasyTypes of Markets and Trading Venues

When a broker-dealer executes a customer trade by purchasing securities directly into its own inventory, in what capacity is the firm acting, and how is it compensated?

  1. A
    Agent capacity, charging a commission
  2. Principal capacity, charging a mark-downAnswer
  3. C
    Primary market issuer capacity, receiving net proceeds
  4. D
    Depository and clearing capacity, charging a netting fee

Answer

Principal capacity, charging a mark-down
A broker-dealer that trades directly with a customer by purchasing securities into its own inventory acts in a principal (or dealer) capacity. When taking the opposite side of the transaction by purchasing from the customer, the firm earns its revenue by applying a mark-down to the purchase price.

Step-by-Step Solution

1
Identify the trading capacity when buying into firm inventory
Buying for or from firm inventory means acting as a principal (dealer).
Brokers act as agents for commissions, whereas dealers act as principals using their own inventory.
2
Determine the compensation type for buying from a customer
When purchasing from a customer, the firm buys at a price below the prevailing market price (a mark-down).
Principals add a mark-up when selling to customers and apply a mark-down when buying from customers.

Key Concept

Broker (Agent) vs. Dealer (Principal) Capacity
Estimated Time:45s
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Topics

Types of Markets and Trading Venues

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