Securities Trader Representative (Series 57) Practice Exam

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How does a riskless principal transaction benefit the broker-dealer?

It avoids market risk
It guarantees higher commissions
It prevents conflicts of interest
It provides better pricing for clients

The correct answer is: It avoids market risk

A riskless principal transaction benefits the broker-dealer primarily by avoiding market risk. In this type of transaction, the broker-dealer acts as a principal by first buying a security from one party and then immediately selling it to another party, typically at a predetermined price. Since the buying and selling occur in quick succession, the broker-dealer is insulated from price fluctuations that could occur if the securities were held for a longer period. This structure allows the broker-dealer to execute trades without the exposure to market volatility, ensuring a more stable revenue stream from these transactions. While other options may seem relevant, they do not directly explain the primary benefit of riskless principal transactions. For instance, guaranteeing higher commissions is not inherently tied to the nature of riskless principal transactions, as commission structures can vary independently of the transaction type. Preventing conflicts of interest and providing better pricing for clients also relate to broader themes of ethical practices and market competitiveness, rather than being specific advantages of the riskless principal transaction mechanism itself.