Securities Industry Essentials (SIE) ExamKnowledge of Capital MarketsEasy
A broker-dealer is facilitating a transaction where they are purchasing shares from a client into their own inventory, and then selling those shares to another client from their inventory. In this scenario, the broker-dealer is acting as a:
- APrincipal
- BAgent
- CCustodian
- DUnderwriter
Show answer & explanationAnswer & explanation
Correct answer: A. Principal
When a broker-dealer buys or sells securities for its own account (i.e., from or into its inventory), it is acting as a principal. This means it takes on the risk of ownership.
Why the other options are wrong
- B. An agent facilitates a transaction between two parties without taking ownership of the securities.
- C. A custodian holds securities for safekeeping.
- D. An underwriter helps an issuer bring new securities to market.
Principal (Broker-Dealer Role)
When a broker-dealer acts as a principal, it buys or sells securities for its own account, taking ownership of the securities. It profits from the spread between the purchase and sale price.
- Acts for its own account.
- Takes ownership of the securities.
- Involves inventory risk.
- Profits from the bid-ask spread.
Memory trick: Principal = 'P'ossession, 'P'rofit from inventory.