Definition of Markdown


What is a rebate?

A finance downgrade is the difference between the highest current offering price among dealers in the market for a security and the lowest price a dealer charges a customer. Sometimes merchants will offer lower prices to stimulate trade; the idea is to compensate the losses with extra commissions.

Key takeaways

  • A finance downgrade is the difference between the highest current offering price among dealers in the market for a security and the lowest price a dealer charges a customer.
  • Subtracting the domestic market price from the price a distributor charges retail customers gives a margin. This margin is known as a markdown if the margin is negative; it is called marking if it is positive.
  • Margins are more common than markdowns because market makers can generally get more favorable prices than retail customers.

Understanding sales: offers and spreads

In finance, bid prices are the amount that buyers are offering to pay. Sales prices are the amounts that sellers are willing to accept. The difference between the highest bid price and the lowest bid price is called the bid-ask spread.

The internal market is the negotiation of a particular security that occurs between market makers (traders who meet specific criteria). The domestic market generally has lower prices and smaller margins than the market for retail investors.

Discounts and surcharges in finance

Subtracting the domestic market price from the price a distributor charges retail customers gives a margin. This spread is known as a downgrade if the spread is negative. The margin is called the profit margin if it is positive.

Margins are more common because market makers can generally get more favorable prices than retail customers. Market makers can buy securities in bulk and domestic markets are more liquid.

However, there are situations in which markdowns occur. For example, a municipal bond issue might not be as in demand as a trader thought. In this case, they could be forced to reduce the price to liquidate their inventory. Traders may believe that by lowering prices, they can generate enough trading activity to offset their losses through commissions.

Financial firms do not have to disclose margins and markdowns on major transactions.

Sales and disclosure

It is important to note that financial firms do not have to disclose margins and markdowns on major transactions. Therefore, an investor may easily not realize the price difference. A main transaction occurs when a trader sells a security from his own account and at his own risk. An agency transaction occurs when a broker facilitates a transaction between a client and another entity.

In the US, many companies combine the roles of broker and dealer. These companies are stockbrokers. When you buy a security from a broker, the financial transaction can be either a principal transaction or an agency transaction.

Stock brokers must disclose how a trade is completed in the trade confirmation, along with commissions. However, they are not required to disclose markups or markdowns, except in certain circumstances.

Special Considerations: Excessive Spreads

Regulators generally consider margins and markdowns of more than 5% unreasonable, but this is only a guide. Discounts of more than 5% may be justified in light of prevailing market conditions. Relevant market conditions include the type of security, the broader pattern of margins and markdowns of the distributor, and the price of the security.

As a general rule, the best brokers keep spreads well below excessive levels due to intense competition in the financial markets. High margins are also more likely to be a problem with under-traded securities.

www.investopedia.com

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Mark Holland

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