Third Market

Which of the following transactions takes place in the primary market?

1. A.A company sells newly issued shares to investors through its underwritersCorrect — new shares sold by the issuer for its own benefit is the definition of a primary market transaction.
2. B.An investor sells 100 listed shares through her broker on the NYSEThat is a secondary market trade between investors — the issuer receives nothing.
3. C.A dealer sells exchange-listed stock to a customer over the counterListed stock trading OTC is the third market — again secondary, because the shares already exist.
4. D.Two institutions trade a block of stock directly through an ECNDirect institution-to-institution trading is the fourth market — a corner of the secondary market.

Why: The primary market is where an issuer sells newly created securities and receives the proceeds — a company selling new shares through its underwriters is the textbook case. Every other choice is investors trading existing shares.

The third market is best described as...

1. A.Direct trading between institutional investors without an intermediaryThat is the fourth market — the classic mix-up with the third.
2. B.The sale of new issues to the public by underwritersNew issues sold for the issuer's benefit are primary market activity, not third market.
3. C.Trading of unlisted securities on an exchange floorThe third market is the reverse: listed securities trading off the exchange.
4. D.Over-the-counter trading of exchange-listed securitiesCorrect — third market means listed securities changing hands OTC, away from the exchange.

Why: The third market is over-the-counter trading of exchange-listed securities — listed stock changing hands away from the exchange floor or its electronic book.

An institution buys a large block of an NYSE-listed stock directly from a broker-dealer that trades the security over the counter, away from any exchange. In which market did the trade occur?

1. A.The primary market, because the institution acquired the block in a single negotiated transaction.Wrong. The primary market is where an issuer sells its own new securities and receives the proceeds.
2. B.The fourth market, because the trade was negotiated privately rather than executed on an exchange.Wrong. That market is defined by institutions dealing directly with each other with no broker-dealer involved.
3. C.The second market, because over-the-counter trading of any security occurs there by definition.Wrong. That term describes over-the-counter trading of unlisted securities rather than listed ones traded off-exchange.
4. D.The third market, because an exchange-listed security traded over the counter with a broker-dealer is what defines it.Correct. Listed status plus an off-exchange venue with a dealer counterparty is exactly the definition.

Why: Trading exchange-listed securities over the counter, away from the exchange on which they are listed, is the third market. It exists because a broker-dealer willing to commit capital can absorb a block that would move the price if it were worked on the exchange, and an institution often values that certainty more than the exchange's displayed liquidity. The defining features are the listed status of the security and the off-exchange venue, and the presence of a broker-dealer as counterparty. Remove the broker-dealer entirely, so that two institutions deal directly with each other over a network, and the transaction becomes a fourth market trade instead.

A mutual fund and a pension fund negotiate and execute a large block trade of exchange-listed stock directly with each other over an ECN, with no broker-dealer involved. This trade occurred in the...

1. A.Primary marketNo issuer and no new securities are involved — the shares already exist.
2. B.Fourth marketCorrect — institutions trading directly with each other through an ECN, with no intermediary, is the fourth market.
3. C.Second marketThere is no separate second market; ordinary investor-to-investor trading is the secondary market, and this is its fourth-market corner.
4. D.Third marketThe third market involves a broker-dealer trading listed stock OTC — here there is no intermediary.

Why: Direct institution-to-institution trading with no broker-dealer intermediary — typically large blocks routed through ECNs or dark pools — is the fourth market.