Riskless Principal Transactions

If a brokerage firm receives a customer order to buy or sell a security and the firm does not have an inventory position in the security, the firm may still elect to execute the order on a principal basis. If the firm elects to execute the order on a principal basis, this is known as a riskless principal transaction. Because the dealer is only taking a position in the security to fill the customer’s order, the dealer is not taking on any risk. As a result the mark up or mark down on riskless transactions will be based on the dealer’s actual cost, not on the inside market. Let’s look at an example:

Example:

Bid                  Ask

10.00              10.05

A customer wants to purchase 100 shares ABCD from the dealer and the dealer executes the order on a principal basis by purchasing the shares for its own account at $10.02 only to immediately resell the stock to the customer. The markup in this case must be based on the dealer’s actual cost of $10.02 and the maximum the dealer could charge the customer would be $10.521 per share or $1,052.10 for the entire order.

Proceeds Transactions

In a proceeds transaction, the customer sells a security and uses the proceeds from that sale to purchase another security on the same day. FINRA’s 5% policy states that: a firm may only charge the customer a combined commission or mark up and mark down of 5% for both transactions, not 5% on each.



Dominated And Controlled Markets

Related Articles
  1. Investing

    Brokerage Functions: Underwriting And Agency Roles

    Learning about these various activities can give insight into how securities are issued and traded.
  2. Professionals

    What Does a Dealer Do?

    Dealers possess certain qualities that distinguish them from brokers and traders.
  3. Markets

    What Does Principal Mean?

    For banks, principal refers to the amount due on a loan, and is used to calculate interest payments.
  4. Investing

    Principal Trading and Agency Trading

    Ever wonder what happens behind the scenes when you buy or sell a stock? Read on and find out!
  5. Investing

    What's a Dealer Market?

    In a dealer market, market participants buy and sell through dealers who are designated as market makers.
  6. Investing

    Is The Series 24 Exam Hard?

    What makes the series 24 so challenging? The exam focuses very heavily on the supervision of trading and market making and the supervision of investment banking.
  7. Financial Advisor

    How Brokers Are Compensated for Selling Bonds

    Find out how brokers are paid for selling bonds and how the transaction costs are passed on to the investor through a markup or commission.
  8. Investing

    What Are Transaction Costs?

    Transaction costs are expenses incurred from buying or selling securities.
  9. Financial Advisor

    What Is A “Broker-Dealer” And Why Should You Care?

    For many investors, the financial services industry is a strange and mysterious place filled with a language all in its own. Terms like “alpha,” “beta” and “Sharpe-Ratio” ...
  10. Trading

    Making The Trade: Understand Order Types

    Buying and selling stock can be a lot like buying or selling a car. Traders should use and understand tools such as market orders, limit orders, day orders, and good-'til-canceled orders to ensure ...
Trading Center