Markdown

A firm charges a 4.6% markup on a thinly traded stock, and its principal argues the charge must be acceptable because it came in under the threshold. FINRA's 5% policy is:

1. A.A fairness guideline for markups and commissionsCorrect - a guideline, not a strict cap.
2. B.A hard maximum commission of 5%The number in the name invites this reading, but the policy is a guideline rather than a ceiling. What matters is whether the total charge is fair given the security, the size of the trade, and the work involved.
3. C.A tax rateNothing about the policy concerns taxation. It addresses what a broker-dealer may charge a customer in markups, markdowns, and commissions.
4. D.A minimum commissionThis turns the guideline upside down. It exists to keep charges from becoming excessive, and a rule requiring firms to charge at least a set amount would work against the customer it is meant to protect.

Why: The 5% policy is a guideline that markups, markdowns, and commissions should be fair and reasonable - not a hard limit.

Which statement best defines a markdown?

1. A.The amount a dealer adds to the market price when selling to a customerThat describes a markup, which applies when the customer is the buyer.
2. B.A reduction in a security's price caused by a declining marketThis confuses a compensation term with ordinary price movement.
3. C.The amount a dealer subtracts from the market price when buying from a customerCorrect. The dealer pays the customer less than the prevailing price, and that difference is the markdown.
4. D.A stated fee charged for arranging a trade between two customersThat is a commission, which is agency compensation rather than a price adjustment.

Why: A markdown is the amount a dealer subtracts from the prevailing market price when buying a security from a customer into its own inventory. It is the principal-capacity equivalent of a commission on a sale.

A customer buys 500 shares through her firm. The trade confirmation discloses that the firm charged a markup on the trade. In what capacity did the firm act?

1. A.As an underwriter in a public offeringUnderwriting involves distributing new issues for an issuer — this is an ordinary secondary-market trade from inventory.
2. B.As an investment adviser to the customerAdvisers charge fees for advice — they are not defined by executing trades, and a markup is trade compensation.
3. C.As a principal, selling from its own inventoryCorrect — a markup is principal compensation, charged when the firm is the counterparty to the trade.
4. D.As an agent, matching the customer with another sellerAgents earn commissions, not markups. A markup means the firm itself sold the shares.

Why: A markup means the firm sold the customer securities from its own inventory — that is principal (dealer) capacity. Agents charge commissions; principals charge markups or markdowns.

Weyland Crest Securities does two things on Tuesday. First, it buys 5,000 shares of Ostrander Mills into its own inventory and later that day sells 800 of those shares to a retail customer at a marked-up net price. Second, it receives a customer order for 300 shares of a listed stock, routes it to an exchange, and charges a stated commission. In these two transactions Weyland Crest acted as:

1. A.A broker on the Ostrander Mills sale and a dealer on the listed stock orderThis reverses the two. Inventory and market risk define the dealer capacity, not order routing.
2. B.A dealer on the Ostrander Mills sale and a broker on the listed stock orderCorrect. Selling from inventory at a marked-up net price is principal activity; routing an order for a commission is agency activity.
3. C.A broker in both transactions, because a customer was on the other side of each tradeThe presence of a customer does not establish agency. What matters is whether the firm traded for its own account.
4. D.A dealer in both transactions, because a registered broker-dealer always acts as principalA single firm regularly switches between capacities, sometimes within the same day.

Why: When a firm buys and sells for its OWN account, taking the security into inventory and bearing the market risk, it acts as a dealer, or principal, and is compensated by a markup or markdown built into the net price. When it merely executes a customer's order with a third party without taking a position, it acts as a broker, or agent, and is compensated by a disclosed commission. The compensation label on the confirmation follows directly from the capacity.