Simple English definitions for legal terms
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Market-making is when a broker-dealer sets the prices for stocks that are not traded on a stock exchange. They do this by reporting the prices they are willing to buy and sell the stocks for. The broker-dealer buys and sells the stocks for their own account, which means they accept offers to both buy and sell the stocks. This practice is regulated by the NASD and the SEC.
Definition: Market-making is the process of setting prices for securities that are not traded on a formal exchange by providing bid-and-asked quotations. A broker-dealer who engages in market-making buys and sells securities for its own account, and accepts both buy and sell orders.
Example: Let's say you want to buy shares of a small company that is not listed on a major stock exchange. You contact a broker-dealer who is a market-maker for that company's stock. The market-maker provides you with a bid-and-asked quotation, which shows the price at which they are willing to buy and sell the stock. You decide to buy the stock at the quoted price, and the market-maker sells it to you from their own inventory.
Explanation: Market-making is an important function in the financial markets because it provides liquidity for securities that are not traded on formal exchanges. Market-makers help to ensure that buyers and sellers can transact at fair prices, and they also help to reduce the bid-ask spread (the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept). By buying and selling securities for their own account, market-makers take on some risk, but they also have the potential to earn profits from the bid-ask spread.