Quick Answer
Introducing broker-dealers take customer orders but never hold client assets; clearing broker-dealers (custodians) hold funds and securities and settle trades. Market makers trade as principal, quote both sides continuously, and profit from the spread. Exchanges match orders and provide price transparency and regulatory oversight.
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))
Exam Tip: Gotchas
- Introducing broker-dealers do not hold client assets. Clearing broker-dealers do.
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
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