Quick Answer
A quote shows the bid (highest buyer price) and ask (lowest seller price); the spread between them is an implicit cost. Orders come in four types (market, limit, stop, stop-limit). A firm acts as agent (broker, earns a commission) or principal (dealer, earns a markup or markdown), never both on one trade, and always owes best execution.
The whole unit on one sheet: the vocabulary, the order types, who does what, and what trading actually costs.
The One-Liners That Win Points
- Bid = highest price a buyer will pay; ask (offer) = lowest price a seller will accept; the spread is the gap between them.
- Narrow spread = high liquidity; wide spread = low liquidity. The spread is a real cost even though no one bills you for it.
- Market order: guarantees execution, not price. Limit order: guarantees price (or better), not execution.
- Stop order becomes a market order when triggered; stop-limit becomes a limit order when triggered.
- Agent (broker) earns a commission; principal (dealer) earns a markup (selling to a customer) or markdown (buying from a customer).
- A firm charges a commission OR a markup on a given trade, never both.
- Market makers profit from the spread, quote continuous two-sided prices, and provide liquidity from their own inventory.
- Custodians hold and safeguard assets; they do NOT make investment decisions.
- Best execution applies to BOTH principal and agency transactions, not just agency.
Order Placement Cheat Sheet
| Order | Placement | Purpose |
|---|---|---|
| Buy limit | Below market | Buy at a lower price |
| Sell limit | Above market | Sell at a higher price |
| Sell stop | Below market | Limit losses / protect profits on a long position |
| Buy stop | Above market | Limit losses on a short position / enter on breakout |
Numbers to Lock In
| Item | Value |
|---|---|
| Regulation T initial margin (Federal Reserve Board) | at least 50% of purchase price |
| Maintenance margin (Financial Industry Regulatory Authority) | at least 25% equity at all times |
| FINRA markup guideline | generally should not exceed 5% of prevailing market price |
Roles in Securities Trading
- Broker-dealer: facilitates transactions; agent capacity earns a commission, dealer capacity earns a markup or markdown. Never both hats on the same trade.
- Custodian: holds and safeguards assets; handles settlement, record-keeping, and reporting (large banks). No investment decisions.
- Market maker: a dealer standing ready to buy and sell; profits from the bid-ask spread. NYSE has ONE Designated Market Maker per security; Nasdaq has MULTIPLE competing market makers.
- Exchange: the regulated marketplace (New York Stock Exchange, Nasdaq, Chicago Board Options Exchange). Exchanges are self-regulatory organizations under Securities and Exchange Commission oversight, not government agencies.
Costs of Trading
- Commission: explicit cost on agency (broker) trades; must be disclosed on the confirmation.
- Markup / markdown: explicit cost on principal (dealer) trades; must be fair and reasonable.
- Bid-ask spread: implicit cost on all trades; paid twice on a round trip (buy at the ask, sell at the bid).
- Payment for order flow: a market maker pays the broker for routed orders; must be disclosed and raises a conflict of interest (routing to the highest rebate rather than the best price).
Top Gotchas
- Stop = market (execution likely); stop-limit = limit (price protected but may not fill). The exam tests this distinction constantly.
- Regulation T (50% initial) is set by the Federal Reserve; maintenance margin (25%) is set by FINRA. The Fed sets the entry bar, FINRA sets the ongoing floor.
- Cash accounts: paid in full, no borrowing, no short selling. Short selling requires a margin account and is subject to Regulation SHO (locate before selling).
- Short selling has unlimited risk because a stock has no ceiling.
- The 5% markup policy is a guideline, not a hard rule or ceiling. Above 5% is not automatically a violation; below 5% is not automatically reasonable.
- A margin call is issued when equity falls below the maintenance level; unmet, the firm can liquidate positions without consent.
- Best execution does not mean the absolute best price every time; it means reasonable diligence across price, speed, likelihood, and settlement.
One-Breath Recap
A quote pairs the bid (highest buyer price) with the ask (lowest seller price), and the spread between them is an implicit round-trip cost that widens as liquidity thins. Orders trade off execution against price: market guarantees execution, limit guarantees price, a stop becomes a market order when triggered, and a stop-limit becomes a limit order. A broker-dealer wears one hat per trade, agent (commission) or principal (markup or markdown) but never both, while custodians safeguard assets, market makers supply liquidity off the spread, and exchanges provide the regulated venue. Lock in Regulation T's 50% initial margin from the Federal Reserve, FINRA's 25% maintenance floor and 5% markup guideline, and the rule that best execution applies to principal and agency trades alike, and this unit answers itself.
Need more than the recap? This is a condensed summary. If it is not enough, read the full Trading Securities unit for the complete lesson.