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1.3.3 Principal And Agency Functions Of Investment Dealer

Gain an in-depth understanding of the principal and agency functions of investment dealers. Learn how these roles impact the trading of securities and the services provided by investment dealers.

Overview of the Principal And Agency Functions of an Investment Dealer

Investment dealers facilitate the trading of securities and the transfer of capital between suppliers and users. They operate in principal and agent capacities, each involving different responsibilities and risk profiles.

Principal Transactions

When acting as principals, investment dealers own the securities as part of their inventory during transactions. The difference between the purchase price and the selling price of the securities constitutes their gross profit or loss.


Underwriting is a significant principal transaction involving purchasing new issues of securities from a government body or a company, executed on a specified date at an agreed price. Here, investment dealers use their capital to purchase securities, aiming to sell them at a profit in the primary market.

Another aspect of principal transactions includes maintaining an inventory and trading securities in the secondary markets. Dealers buy these securities in the open market, hold them in inventory for varied periods, and eventually sell them.

Agency Transactions

Investment dealers, acting as agents for buyers or sellers, do not hold the securities they facilitate. Their profit comes from commissions for each transaction they execute.

In these scenarios, the principals are the clients who own and trade the securities. Agents charge their client a commission to complete the sale or purchase.

FAQ: What is a Broker?

Generally, a broker acts as an agent on behalf of clients. However, the term broker is often used to describe an investment dealer acting in any capacity.

Example Diagram of Transactions

    graph TB
	    subgraph Principal
	        A1(Seller) -->|Sells to| B1(Buyer)
	    subgraph Agent
	        A2(Seller) -->|Broker Commission| B2(Buyer)

Services Provided by Investment Dealers

Adding Market Liquidity and Enhancing Transactions

Investment dealers play a crucial role in the financial market by offering the following services:

  • Informed Market Advice: Provide insights into terms and features for new asset issues based on market trends.
  • Market Liquidity: Execute transactions from their inventory, enabling faster trading and better liquidity.
  • Market Makers: Take positions in listed stocks to smooth price fluctuations and enhance liquidity.
  • Large Block Trades: Accumulate significant shares as principals to better serve institutional clients.
  • Primary-Secondary Market Linkage: Ensure that buyers of new issues can find market rates for their securities in the secondary market.

Glossary of Key Terms

  • Principal Transactions: Transactions wherein the investment dealer owns the securities during the transaction.
  • Underwriting: The process of purchasing new security issues from issuers to sell in the primary market.
  • Agency Transactions: Transactions where the dealer acts on behalf of clients without owning the securities, earning through commissions.
  • Market Makers: Dealers who participate in market stabilization by buying or selling securities to provide liquidity.
  • Primary Market: The market where new securities are issued and sold for the first time.
  • Secondary Market: The market where existing securities are traded among investors.

Key Takeaways

  • Roles: Investment dealers can act as principals or agents in securities transactions.
  • Principal Transactions: Discover key aspects like owning securities and underwriting new issues.
  • Agency Transactions: Understand how these transactions involve commissions without holding securities.
  • Market Services Awareness: Learn about essential market services, from liquidity to market-making.

By understanding these roles and services, one can grasp the comprehensive contributions of investment dealers to the financial market’s smooth operation.

CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

markdown ## What role does an investment dealer play when they own securities as part of their inventory? - [ ] Agent - [x] Principal - [ ] Broker - [ ] Underwriter > **Explanation:** When investment dealers own securities as part of their inventory, they are acting as principals. ## In underwriting transactions, what do investment dealers principally do? - [ ] Act as agents to sell securities on behalf of clients - [ ] Hold securities without ownership - [x] Purchase new issues of securities using their own capital and then sell them - [ ] Match buy-sell orders simultaneously > **Explanation:** In underwriting, investment dealers purchase new issues of securities from a government body or company using their own capital and aim to sell them at a profit. ## When acting as an agent, what do investment dealers primarily earn from transactions? - [ ] Gross profit from buying and selling securities - [ ] All profits from price differences - [x] Commissions for executing trades on behalf of clients - [ ] Interest on borrowed securities > **Explanation:** As agents, investment dealers earn commissions for executing buy and sell orders on behalf of their clients. ## When do investment dealers act as principals in secondary markets? - [ ] Only during underwriting transactions - [ ] While advising clients - [x] By maintaining an inventory of already issued securities - [ ] When acting as brokers > **Explanation:** In secondary markets, investment dealers act as principals by maintaining inventories of already issued, outstanding securities. ## When an investment dealer maintains an inventory of securities, they primarily provide what service to the market? - [ ] Matching buy-sell orders simultaneously - [x] Adding liquidity to the market - [ ] Issuing new securities - [ ] Eliminating market volatility > **Explanation:** Investment dealers provide market liquidity by maintaining an inventory of securities and being able to transact from this inventory. ## What is the role of an investment dealer when executing trades as an agent? - [x] Acting on behalf of clients without owning the securities - [ ] Trading from their own account to make a profit - [ ] Underwriting new issues - [ ] Accumulating large blocks of shares > **Explanation:** When acting as agents, investment dealers execute trades on behalf of their clients and do not take ownership of the securities. ## Which service is NOT typically provided by investment dealers? - [ ] Providing informed advice on new issues - [ ] Adding liquidity to the market - [x] Eliminating all market risks - [ ] Acting as market makers > **Explanation:** Investment dealers do not eliminate all market risks; they provide other services like adding liquidity, offering advice, and acting as market makers. ## What is one function that market-making investment dealers sometimes perform? - [ ] Issuing new securities in the primary market - [x] Taking positions in assigned listed stocks to enhance liquidity - [ ] Limiting trading to large institutional clients - [ ] Performing due diligence for clients > **Explanation:** Market-making investment dealers take positions in certain listed stocks to enhance market liquidity. ## In most secondary trading of debt securities, how do investment dealers typically act? - [ ] As agents matching buy-sell orders - [ ] As brokers without inventory - [x] As principals - [ ] As underwriters > **Explanation:** In most secondary trading of debt securities, investment dealers act as principals. ## The term "broker" generally refers to an investment dealer acting in what capacity? - [x] As an agent - [ ] As a principal only - [ ] As an underwriter - [ ] As a client > **Explanation:** The term "broker" often refers to an investment dealer acting as an agent on behalf of clients.

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