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Difficulty: EasyTypes of Markets and Trading Venues

A broker-dealer executes a customer's buy order for stock by selling the shares directly out of its own trading account inventory. In what capacity is the firm acting, and what form of compensation does it charge for this transaction?

  1. As a principal (dealer), charging a mark-upAnswer
  2. B
    As an agent (broker), charging a commission
  3. C
    As an underwriter, receiving an underwriting spread
  4. D
    As a clearing depository, charging a settlement fee

Answer

The broker-dealer is acting as a principal (dealer) and charging a mark-up.
When a firm sells securities directly out of its own inventory to a customer, it is acting as a principal (dealer) taking on financial risk. In principal transactions, the firm earns compensation by adding a mark-up to the prevailing market price.

Step-by-Step Solution

1
Determine the capacity in which the firm is operating during the trade
Because the firm sells securities directly from its own inventory account, it acts as a principal (dealer).
Principal capacity means the firm trades for its own account and assumes inventory risk.
2
Identify the corresponding compensation model for principal trades
Firms acting as principal charge a mark-up on buy orders (or a mark-down on sell orders).
Commissions apply to agency transactions, whereas mark-ups and mark-downs apply to principal transactions.

Key Concept

Broker (Agency) vs. Dealer (Principal) Execution and Compensation
Estimated Time:45s
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Topics

Types of Markets and Trading Venues

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