1.3 Investment Dealer’s Role As Financial Intermediary

Distinguishing Among Categories of Investment Dealers

Investment dealers are broadly categorized into three types based on their organizational structure and operations:

1. Independent Dealers: These are standalone entities not affiliated with any large financial institutions. They often specialize in a specific market niche or client segment.
2. Institutional Dealers: These dealers are associated with large financial institutions such as banks. They mainly operate in complex financial markets and serve institutional clients like mutual funds, pension funds, and insurance companies.
3. Retail Brokers: These entities focus on individual investors or small businesses. They offer services like investment advice, portfolio management, and execution of trades on behalf of their retail clients.

Difference Between Principal and Agency Transactions

Principal Transactions

In principal transactions, the investment dealer acts as the counterpart to the trade and uses its own capital to buy or sell securities. This involves experiencing direct financial risk similar to an investor. For instance, if an investment dealer buys shares directly from an issuing company, it owns the shares and can sell them to investors later.

Agency Transactions

In agency transactions, the investment dealer acts solely as an agent for its clients, buying and selling securities on their behalf without owning the securities directly. The dealer earns commission fees for facilitating these trades.

Key Differences

• Financial Risk: Principal transactions involve direct financial risk for the dealer, while agency transactions transfer that risk to clients.
• Ownership: In principal transactions, investment dealers temporarily own the securities, which is not the case in agency transactions.

Primary and Secondary Market Functions

Primary Market Functions

Investment dealers are fundamental in the primary market, specifically through activities such as underwriting and distribution of new securities. Underwriting involves the dealer purchasing securities from the issuer and reselling them to the public. The primary market distribution includes transactions like Initial Public Offerings (IPOs), where a company offers its stocks to the public for the first time.

Example: Initial Public Offering (IPO)

When a private company issues shares publicly for the first time, this is considered an IPO. For instance, if TechCorp decides to go public and sells its stocks on the primary market, it’s unveiled as an IPO facilitated by an investment dealer.

Secondary Market Functions

Investment dealers also play a central role in the secondary market, which facilitates trading of previously issued securities. Examples include stock exchanges like the Toronto Stock Exchange (TSE) where buying and selling of stocks occur post-initial issuance.

Key Functions

1. Liquidity Provision: Dealers ensure there is enough market liquidity so that investors can buy and sell securities readily without significant price fluctuations.

2. Price Discovery: They participate in the trading that helps establish the market value of securities through supply and demand mechanisms.

FAQ - Frequently Asked Questions

Q1: What is the primary role of an investment dealer in the financial market?

A1: Investment dealers act as intermediaries facilitating the movement of financial instruments between investors, aiding in capital transfers through underwriting and secondary market operations.

Q2: How do principal transactions differ from agency transactions?

A2: Principal transactions involve an investment dealer acting as the counterparty using its own capital, while in agency transactions, the dealer acts as an agent facilitating trades for clients without taking ownership.

Q3: What is an IPO, and which market does it involve?

A3: An IPO, or Initial Public Offering, is when a private company sells stocks to the public for the first time. This transaction occurs in the primary market.

Glossary of Key Terms

• Investment Dealer: A financial intermediary facilitating buying and selling of securities.
• Primary Market: Platform for new securities issuance, including IPOs.
• Secondary Market: Market for trading previously issued securities.
• IPO: Initial Public Offering, a company’s first sale of stock to the public.
• Underwriting: An act of buying and distributing new securities by investment dealers.
• Liquidity: The ability to buy or sell an asset quickly without affecting its price.
• Price Discovery: The process of determining the market price of an asset.

Key Takeaways

• Investment dealers serve essential roles in financial markets by conducting both principal and agency transactions.
• Three categories of investment dealers—Independent, Institutional, and Retail—enable structured operations within varied client segments.
• Active roles in primary markets and secondary markets facilitate liquidity, price discovery, and seamless capital transfer.

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In this section

• 1.3.1 Types Of Investment Dealers
  Learn about the different categories of investment dealers in the Canadian securities industry: Retail firms, Institutional firms, and Integrated firms.
• 1.3.2 Organization Within Firms
  Understand the organization within investment dealer firms, including the roles and functions of the front, middle, and back offices, and the significance of senior management.
• 1.3.3 Principal And Agency Functions Of Investment Dealer
  Gain an in-depth understanding of the principal and agency functions of investment dealers. Learn how these roles impact the trading of securities and the services provided by investment dealers.
• 1.3.4 Clearing System
  Learn about the clearing system used in the Canadian securities market, including the role of CDS Clearing and Depository Services, the netting process, and key roles of an investment dealer.