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Difficulty: EasyTypes of Markets and Trading Venues

A broker-dealer receives an order from a retail customer to buy shares of an exchange-listed stock. The broker-dealer routes the order to the exchange, executes the trade with an independent market maker, and charges the customer a fee for facilitating the transaction. In what capacity did the broker-dealer act during this trade?

  1. As an agent (broker), charging a commissionAnswer
  2. B
    As a principal (dealer), selling shares directly out of its own inventory with a mark-up
  3. C
    As an underwriter, facilitating a primary market transaction for the issuing corporation
  4. D
    As a depository entity, fulfilling clearing and safekeeping responsibilities for the trade

Answer

The broker-dealer acted as an agent (broker), earning a commission for facilitating the trade.
When a broker-dealer connects a buyer and seller or routes a customer order to an exchange to execute against an independent third party, the firm is acting as an agent (broker) and receives compensation in the form of a commission.

Step-by-Step Solution

1
Identify the role of the broker-dealer during the execution.
The broker-dealer routed the customer's order to an exchange to execute against a third party rather than executing against its own inventory.
When a firm acts as a middleman connecting buyers and sellers without taking financial inventory risk, it acts in an agency (broker) capacity.
2
Determine the type of compensation charged in an agency capacity.
The firm charges a commission fee for its services.
Agency transactions are characterized by commission charges, whereas principal transactions involve mark-ups or mark-downs.

Key Concept

Broker (Agency) vs. Dealer (Principal) Capacity in Secondary Market Executions
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Topics

Types of Markets and Trading Venues

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