Agency Transaction

When a broker-dealer executes a trade as agent for a customer, its compensation is a...

1. A.Advisory feeAsset-based advisory fees are investment adviser compensation, not payment for executing a single agency trade.
2. B.MarkupA markup applies when the firm sells to the customer as principal from inventory.
3. C.CommissionCorrect — agency trades are compensated by commissions, disclosed on the confirmation.
4. D.MarkdownA markdown applies when the firm buys from the customer as principal.

Why: Acting as agent means matching the customer with another party rather than trading against them — and agency trades are compensated by commission.

When a firm acts in an agency capacity for a customer, how is the firm compensated?

1. A.A markdownA markdown is also principal compensation, used when the dealer buys from the customer.
2. B.A commissionCorrect. An agent arranges the trade for the customer and charges a stated commission.
3. C.A markupA markup is added to the price in a principal trade from inventory, which is not what happens in agency capacity.
4. D.The bid-ask spreadThe spread is earned by a market maker quoting a two-sided market, not by a broker acting as agent.

Why: An agent arranges the trade between the customer and another party and charges a commission for that service. The firm never takes the security into its own inventory.

Holding no inventory, a firm receives a customer's buy order, immediately purchases the shares in the market for its own account, and then sells them to the customer at a price that includes its compensation. In what capacity did it act?

1. A.As agent, because it held no position before the customer's order arrived and bore no market risk.Wrong. Capacity turns on whether the shares passed through the firm's own account, which they did.
2. B.As principal on a riskless basis, so its compensation is a markup and the capacity must be disclosed.Correct. The offsetting purchase removed the firm's exposure without changing whose account the shares came from.
3. C.As a market maker, because buying and immediately reselling the same security is what market making consists of.Wrong. A market maker quotes continuous two-sided markets and stands ready to trade, which this firm does not.
4. D.As agent for the selling dealer, since the firm sourced the shares from another participant in the market.Wrong. It bought those shares for itself, so no agency relationship with the selling dealer arose.

Why: This is a riskless principal transaction: the firm acted for its own account on both legs, but it took on no market exposure because the offsetting purchase was made only after the customer's order was in hand. Capacity is determined by whether the securities passed through the firm's own account, not by how much risk the firm bore, so the firm acted as principal and its compensation is a markup rather than a commission. Because the customer might otherwise assume a firm holding no inventory must have acted as agent, the capacity has to be disclosed on the confirmation. Had the firm instead sent the order to another dealer and passed the execution through for a fee, it would have acted as agent and charged a commission.

On an exchange floor, what distinguishes a floor broker from a firm that makes markets in the same securities?

1. A.The floor broker trades only for its own firm's customers, while the market maker may trade for anyone.Wrong. Floor brokers commonly execute orders sent by other member firms as well as their own firm's.
2. B.The floor broker handles only orders above a size the exchange specifies, while the market maker handles the rest.Wrong. No such size division defines either role, and both handle orders across a wide range of sizes.
3. C.The floor broker executes as agent for a commission and takes no position; the market maker commits capital and earns a spread.Correct. The agency and principal divide is the distinction, and the economics of each role follow from it.
4. D.The floor broker sets the opening price each session, while the market maker quotes only during continuous trading.Wrong. Opening procedures are run by the exchange's designated market maker rather than by an agency broker.

Why: A floor broker executes orders as agent, handling them for its own firm's customers or for other member firms that have sent business to the floor, and is paid a commission for the service. It takes no position and bears no market risk, so its economic interest lies in execution quality and volume rather than in the direction of prices. A market maker, by contrast, commits its own capital, quotes two-sided markets, and profits from the spread between what it pays and what it receives. The two roles sit on opposite sides of the agency and principal divide even though both are executing trades in the same securities at the same venue.