Explanation
A quote-driven market (also known as a dealer market) is characterized by dealers who post bid and ask prices at which they are willing to buy and sell securities. In this type of market:
- Dealers act as market makers - They maintain an inventory of securities and provide liquidity by standing ready to buy and sell.
- Trading occurs directly with dealers - Buyers and sellers transact with dealers rather than with each other.
- Price discovery comes from dealer quotes - Prices are determined by the bid-ask spreads quoted by dealers.
Why the other options are incorrect:
- A. Brokered market: In a brokered market, brokers act as intermediaries to find counterparties for trades. Buyers and sellers don't trade directly with dealers, but rather brokers help match orders between parties.
- B. Order-driven market: In an order-driven market, buy and sell orders are matched through an electronic order book or auction system. Prices are determined by the interaction of these orders, not by dealer quotes.
Examples of quote-driven markets:
- Over-the-counter (OTC) markets
- NASDAQ (historically a dealer market, though it has evolved)
- Foreign exchange markets (interbank market)
Key characteristics:
- Dealers provide continuous liquidity
- Bid-ask spreads represent the dealer's profit margin
- Less transparent than order-driven markets
- Better for less liquid securities where continuous trading might not be possible
