Legal Definitions - market-maker

A market-maker is a financial firm or individual that plays a crucial role in facilitating the trading of securities, such as stocks, bonds, or options. They do this by continuously offering to buy (at their "bid" price) and sell (at their "ask" price) a particular security, using their own inventory and capital.

By consistently quoting these prices, market-makers ensure that investors can always find a counterparty to complete a trade, even if there isn't another individual buyer or seller immediately available. This activity provides essential liquidity to the market, making it easier and more efficient for others to trade. Market-makers typically profit from the small difference between their bid and ask prices, known as the "spread."

• Example 1: Stock Exchange Trading
  Imagine a large investment bank that acts as a market-maker for shares of a well-known technology company listed on a major stock exchange. Throughout the trading day, this bank continuously displays prices at which it is willing to buy (e.g., $150.00) and sell (e.g., $150.05) shares of this tech company. If an investor wants to sell 1,000 shares, the bank will buy them at its bid price. If another investor wants to buy 500 shares, the bank will sell them from its own holdings at its ask price. This ensures that trades can always occur, providing a constant flow of liquidity for that particular stock.

• Example 2: Corporate Bond Market
  Consider a specialized financial institution that focuses on making a market for corporate bonds issued by companies in the renewable energy sector. These bonds might not be traded as frequently as major stocks. The institution regularly publishes bid and ask prices for various maturities of these bonds. For instance, they might quote a specific bond at a bid of 98.50 and an ask of 99.00. If a pension fund needs to sell a large block of these bonds, the market-maker will purchase them. Conversely, if an insurance company wants to invest in these bonds, the market-maker will sell them from its inventory. This service makes it possible to trade these less liquid assets efficiently.

• Example 3: Exchange-Traded Funds (ETFs)
  A dedicated trading firm operates as a market-maker for a popular Exchange-Traded Fund (ETF) that tracks the performance of a broad market index. This firm constantly provides real-time quotes for buying and selling units of the ETF. If an institutional investor wants to quickly liquidate a significant number of ETF units, the market-maker will step in and buy them. Similarly, if a large fund manager wishes to acquire a substantial amount of the ETF, the market-maker will sell units from its own holdings. This continuous activity ensures that the ETF can be traded smoothly throughout the day, and its price remains closely aligned with the value of its underlying assets, even during periods of high demand or supply from other investors.