Legal Definitions - market-making

Definition: Market-making is the process of setting prices for securities that are not traded on a formal exchange by providing bid-and-asked quotations. A broker-dealer who engages in market-making buys and sells securities for its own account, and accepts both buy and sell orders.

Example: Let's say you want to buy shares of a small company that is not listed on a major stock exchange. You contact a broker-dealer who is a market-maker for that company's stock. The market-maker provides you with a bid-and-asked quotation, which shows the price at which they are willing to buy and sell the stock. You decide to buy the stock at the quoted price, and the market-maker sells it to you from their own inventory.

Explanation: Market-making is an important function in the financial markets because it provides liquidity for securities that are not traded on formal exchanges. Market-makers help to ensure that buyers and sellers can transact at fair prices, and they also help to reduce the bid-ask spread (the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept). By buying and selling securities for their own account, market-makers take on some risk, but they also have the potential to earn profits from the bid-ask spread.