Secondary Security Markets: Quote-Driven Markets

A market maker for AJ Metals, a fictitious company listed on the NASDAQ exchange, plans to offer USD 15.28/share but bids USD 15.27/share and is trying to find someone willing to sell to him for that price. Why is finding this seller important?

Yes. Even though it is only 1 penny per share in this example, the market maker earns through the bid-ask spread. This is the difference between the price he is trying to sell AJ Metals for and the price he is able to successfully buy it for. Always remember the famous phrase, "Buy low, sell high!"

No. The seller does not have to raise his price and sell at a higher price (unless he wants to), but there would be no way for the seller to know what the market maker's offer price is going to be once he makes the deal.

No. The market maker does not own any shares of anything yet. He is trying to establish a small marketplace.

Thinking back to AJ Metals, what could make the quote-driven market the optimal place to trade this security, or any other security?

Yes. If this security is one that has low trading volume, a quote-driven marketplace can help liquidity via market makers, maintaining the security's inventory.

No, this is not true. The NASDAQ has very high international visibility as a dealer-priced market. Other markets, such as the NYSE, are auction markets. The type of trading that a company desires and the fees that the exchange charges help investors decide whether the NASDAQ is the optimal place to trade.

No. Less transparency hinders trading somewhat because it is difficult for traders to determine fair pricing. Quote-driven markets only display bid and ask offers of market makers. The market makers will post the bid and ask price that they are willing to accept at that time, which is dynamic quotation.

To summarize: [[summary]]

Customers may conduct trading with dealers in a __quote-driven__, structured marketplace. Traders call this structure quote driven, dealer driven, or price driven because customers trade at dealer-quoted prices. Besides traders who represent buyers and sellers, the most critical role is held by the market maker. Market makers post bid and ask quotes for stock inventory that they want to buy from and then sell to traders. Market makers receive privileges like low exchange fees or the right to post quotes. Market makers are required to make markets in securities by selling and buying at the same time.

Quote-driven markets operate in areas all around the world. These markets are common in over-the counter (OTC) markets such as bond markets and Forex (foreign-exchange) markets. The NASDAQ, which was previously mentioned, is an example of an equity-based market that operates mainly as a quote-driven market.

The market maker must sell the shares he owns

The market maker will make money on the final transaction

The market maker must buy from the seller at USD 15.28/share instead

There are a greater number of traders on the NASDAQ

Liquidity can be improved for traders

Transparency is reduced

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