Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

Which market is characterized by exchange-listed securities traded OTC between broker-dealers and large institutional investors?

1. Primary market

2. Secondary market

3. Third market

4. Fourth market

The correct answer is: Third market

The third market is defined as the trading of exchange-listed securities that occurs over-the-counter (OTC) between broker-dealers and large institutional investors. In this market, transactions take place outside the traditional stock exchanges, allowing institutional players to conduct trades more discreetly and potentially at more favorable prices than those listed on exchanges. This market activity mainly involves large blocks of shares, which can be beneficial for institutions seeking to minimize market impact and maintain liquidity without affecting the publicly quoted prices. The third market serves as a complementary trading venue, providing flexibility for institutions that prefer to trade outside the standard exchange framework. In contrast, the primary market is where securities are created and issued for the first time, primarily involving initial public offerings (IPOs), while the secondary market refers to the trading of already issued securities among investors. The fourth market, on the other hand, pertains to direct trading of securities between institutions without intermediaries, typically through electronic networks. Understanding these distinctions helps clarify the unique role the third market plays in the broader financial ecosystem.