Reviewed by Sep 30, 2020| Updated on
A markdown in finance is the difference between a security market's highest current bid price among dealers and the lower price a dealer charges a customer. Dealers will sometimes offer lower prices to encourage trade with additional fees the aim here is to compensate for the losses.
Subtracting the internal market price from the amount a supplier charges off a spread to retail customers. If the spread is negative, it is known as a markdown it is called a markup if it is positive. Markups are more popular than markdowns as market makers typically get offers that are more favorable than retail customers.
It is important to note that financial firms in principal transactions do not need to disclose markups and markdowns. So an investor can easily ignore the difference in price. A principal transaction occurs when a dealer sells security at their own risk and from their own account. An agency contract happens when a broker executes an agreement between a company and another party.
Most companies in the US combine broker and dealer positions, and are called broker-dealers. If you buy security from a broker dealer, the financial transaction may be either a large transaction, or an agency transaction. Broker-dealers and any commissions must disclose how trade is completed in the trade confirmation. We need not report markups or markdowns, however, except in certain situations. Regulators view markups and markdowns of over 5% as unfair, but this is a guideline only. In view of the prevailing market conditions, markdowns of 5% to 10% can be justified.
Relevant market conditions include security type, broader pattern of markups and markdowns by the dealer, and security price. Undisclosed spreads on exchange-traded securities of more than 10% are considered fraudulent.