Reading 41: Execution of Portfolio Decisions－LOS d dealers, contrast

tycoon

CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 14: Execution of Portfolio Decisions
Reading 41: Execution of Portfolio Decisions
LOS d: Compare and contrast the roles of brokers and dealers.

tycoon

In which of the following relationships does the adverse selection risk problem pertain?

A) Trader and dealer.

B) Trader and investor.

C) Broker and dealer.

D) Trader and broker.

---

Answer and Explanation

A trader is more likely to trade with a dealer when he has information that the dealer does not. This results in adverse selection risk for the dealer. The traders profit is the dealers loss once the information is revealed to the market.

tycoon

In which of the following is there a principal-agent relationship?

A) Trader and analyst.

B) Broker and dealer.

C) Trader and dealer.

D) Trader and broker.

---

Answer and Explanation

A principal-agent relationship exists between a trader and the broker. The broker acts as the traders agent and locates the necessary liquidity at the best price. The trader can also extract information from the broker regarding the depth of a market and the identity of other traders.

tycoon

Which of the following relationships is adversarial?

A) Trader and investor.

B) Broker and dealer.

C) Trader and broker.

D) Trader and dealer.

---

Answer and Explanation

The relationship between a trader and a dealer is adversarial. The dealer would like to maximize the trade spread and the trader would like to minimize it. Also, when a trader has information that the dealer does not, the trader profits at the dealers expense.