Dealers and Brokers

Because most securities transactions involve dealers and brokers, it is important to understand exactly what is meant by the terms dealer and broker. A dealer maintains an inventory and stands ready to buy and sell at any time. In contrast, a broker brings buyers and sellers together, but does not maintain an inventory. Thus, when we speak of used car dealers and real estate brokers, we recognize that the used car dealer maintains an inventory, whereas the real estate broker does not.

dealer

An agent who buys and sells securities from inventory.

broker

An agent who arranges security transactions among investors.

Ross et al.: Fundamentals III. Valuation of Future 8. Stock Valuation © The McGraw-Hill of Corporate Finance, Sixth Cash Flows Companies, 2002

Edition, Alternate Edition

258 PART THREE Valuation of Future Cash Flows

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In the securities markets, a dealer stands ready to buy securities from investors wishing to sell them and sell securities to investors wishing to buy them. Recall from our previous chapter that the price the dealer is willing to pay is called the bid price. The price at which the dealer will sell is called the ask price (sometimes called the asked, offered, or offering price). The difference between the bid and ask prices is called the spread, and it is the basic source of dealer profits.

Dealers exist in all areas of the economy, not just the stock markets. For example, your local college bookstore is probably both a primary- and a secondary-market textbook dealer. If you buy a new book, this is a primary-market transaction. If you buy a used book, this is a secondary-market transaction, and you pay the store's ask price. If you sell the book back, you receive the store's bid price, often half of the ask price. The bookstore's spread is the difference between the two prices.

In contrast, a securities broker arranges transactions between investors, matching investors wishing to buy securities with investors wishing to sell securities. The distinctive characteristic of security brokers is that they do not buy or sell securities for their own accounts. Facilitating trades by others is their business.

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