Costs are the one certain part of investing. The customer pays them whether the investment wins or loses, and most never show up as a separate line on the trade date. The exam asks whether you can price a trade fairly, match a share class to the customer and explain where every fee goes.
A firm fills a customer order in one of two capacities, and each one earns money differently:
- Agent (broker): The firm finds the other side of the trade and charges a commission shown on the confirmation.
- Principal (dealer): The firm buys from or sells to the customer out of its own account.
- Markup: The amount a principal adds above the market price when it sells to a customer.
- Markdown: The amount a principal subtracts below the market price when it buys from a customer.
A markup is built into the price, so the customer can't easily see it. That is why the Financial Industry Regulatory Authority (FINRA), the self-regulatory organization for broker-dealers, requires a fair price on every principal trade under...
Common mistakes
- Treating 5% as a ceiling or a safe harbor (see the TRAP above).
- Applying Rule 2121 or the 5% Policy to municipal bonds. Munis follow MSRB Rule G-30, which judges price mainly by comparable yield.
- Dividing the load by NAV. With a $10.00 POP and a $9.425 NAV, the charge is 5.75% of POP. Dividing by NAV gives the wrong figure: $0.575 ÷ $9.425 = 6.1%.
Bottom line
- FINRA Rule 2121 markups run from the prevailing market price, and because the 5% Policy is a guide, a markup of 5% or less can still be unfair.
- Proceeds trades combine the markdown on the sale with the markup on the purchase.
- Munis follow MSRB Rule G-30, judged by comparable yield with no percentage test.
- A net trade by a market maker needs the retail customer's written consent order by order (Rule 2124).
Exam shortcut
Start every pricing question by naming the capacity and the product. A principal trade in stock, corporate bonds or Treasuries points to Rule 2121 and its factors. A municipal bond points to G-30 and comparable yield. A prospectus offering at the POP raises no markup question at all. Eliminate any choice that calls 5% a maximum or calls a markup under 5% automatically fair.
The full lesson (about 4,939 words, 33 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C27
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