Auction Market

Two orders in the same stock are executed, one on an exchange and one through a dealer's over-the-counter desk. What distinguishes how the price was determined in each case?

1. A.The exchange price was set by the listed company; the dealer price was negotiated.Wrong. A listed company does not set the price of its shares at any point after the offering is complete.
2. B.Both prices were set by a dealer, since every trade needs a firm to take the other side.Wrong. On an auction market one customer's order can be filled directly by another customer's order.
3. C.The exchange matched competing customer orders; the dealer quoted a price from inventory.Correct. An auction market matches buyers with sellers, while a dealer market runs on quoted two-sided prices.
4. D.Both were matched against competing orders, since exchanges and dealers share one book.Wrong. There is no single consolidated book, and dealer markets are built on quotations rather than matching.

Why: An exchange operates as an auction market: buy and sell orders compete, and a trade occurs when the highest bid meets the lowest offer, with a designated market maker supplying liquidity where natural orders do not meet. The over-the-counter market is a dealer market, where firms publish two-sided quotations and stand ready to buy at their bid and sell at their offer out of their own inventory. The customer's counterparty is therefore another investor in the first case and the dealer itself in the second. That distinction is also why one trade carries a commission and the other a markup.

Which statement best distinguishes an exchange from the over-the-counter market?

1. A.An exchange is a centralized auction market with listing standards; the OTC market is a decentralized negotiated dealer networkCorrect. The contrast is centralized auction versus decentralized negotiation, plus formal listing standards versus quotation eligibility.
2. B.Exchanges are regulated by the SEC; the OTC market is unregulatedWrong. OTC trading is fully regulated by the SEC and FINRA. Decentralized is not the same as unregulated.
3. C.Exchange trades are secondary market transactions; OTC trades are primary market transactionsWrong. Both are secondary market venues. Neither routes money to the issuer.
4. D.Only exchanges use market makers; the OTC market uses brokers onlyWrong, and reversed in emphasis. Market makers are the backbone of the OTC market, and exchanges use designated liquidity providers too.

Why: An exchange is a centralized auction market with listing standards where orders interact in one book. The OTC market is a decentralized negotiated network of dealers connected electronically, with no central floor and looser eligibility.