Role of Market Participants

Trade execution splits across several distinct roles. This section covers who takes the order, who holds the assets, who provides liquidity, and where the trade is actually matched.

What Does an Introducing Broker-Dealer Do?

• Maintains the customer relationship and accepts orders
• Does not hold customer funds or securities and does not clear or settle trades
• Routes orders to a clearing broker-dealer for execution and settlement

What Does a Clearing Broker-Dealer Do?

• Holds customer funds and securities (custody)
• Processes, clears, and settles trades
• Sends trade confirmations and account statements
• Direct member of a clearing agency (e.g., Depository Trust & Clearing Corporation (DTCC) / National Securities Clearing Corporation (NSCC))

Custody is a function, not always a separate firm. A clearing broker-dealer performs it for the accounts introduced to it, which is why the sponsor treats "clearing broker-dealer" and "custodian" as one role. A separate custodian, often a bank, may instead hold and safeguard the assets and report on them without executing or settling any trades.

Exam Tip: Gotchas

• Introducing broker-dealers do not hold client assets. Clearing broker-dealers do.
• "Custodian" names the safekeeping function. When the question contrasts a custodian with a clearing firm, it is separating safekeeping and reporting from trade settlement. When it pairs them, it is describing the clearing broker-dealer that does both.

What Is the Role of a Market Maker?

• Stand ready to buy and sell a particular security on a continuous basis at publicly quoted prices
• Trade as principal from their own inventory
• Provide liquidity to the market
• Profit from the bid-ask spread
• Required to maintain a two-sided quote (both bid and offer)

Exam Tip: Gotchas

• When acting as a market maker, the firm trades as PRINCIPAL from its own inventory and is compensated by the spread, not a commission. A question that describes "bid-ask spread" or "two-sided quote" is pointing at principal/market-maker activity.

What Is the Role of an Exchange?

• Centralized, regulated marketplaces where securities are listed and traded (e.g., NYSE, Nasdaq)
• Provide price transparency, fair and orderly trading, and regulatory oversight
• Match buy and sell orders through an electronic order book or auction system
• Issuers must meet the exchange's own listing standards to trade there

How Does an Exchange Differ from the OTC Market?

• Not every security trades on an exchange. Many securities, including Treasury securities, most bonds, and some smaller stocks, trade in the over-the-counter (OTC) market instead
• The OTC market is a decentralized, dealer-negotiated market. Dealers quote prices and trade directly with customers and each other, rather than through one central order book
• OTC trading does not depend on any single exchange's listing process

Exam Tip: Gotchas

• Nasdaq is a registered national securities exchange, not an OTC market. Nasdaq's trading is electronic and has no physical floor, but that does not make it OTC. A question that calls Nasdaq "OTC" because of its electronic structure is testing this distinction.

What Should You Check on Exam Day?

• Introducing broker-dealers accept orders and maintain the customer relationship but do not hold customer funds or securities
• Clearing broker-dealers hold custody, process settlement, and send confirmations and statements; they are direct members of a clearing agency such as DTCC/NSCC
• When acting as a market maker, the firm trades as principal from its own inventory, must maintain a two-sided quote, and profits from the bid-ask spread rather than a commission
• Exchanges provide price discovery and order matching but do not hold customer assets
• Not every security trades on an exchange; many, including Treasury securities and most bonds, trade in the decentralized, dealer-negotiated OTC market instead, and Nasdaq's electronic structure does not make it an OTC market