What is Markdown?

In the common scenarios, markupMarkupThe percentage of profits derived over the cost price of the product sold is known as markup. It is determined by dividing the company’s total profit by the cost price of the product and multiplying the result by 100.read more markdowns because the securities are bought in bulk by the market makers. As the liquidity is more in the inside markets, they can obtain more of the favorable prices generally when compared with the prices the retail customers get. It is not required to disclose these in the principal transactions.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Markdown (wallstreetmojo.com)

Examples of Markdown

Example #1

A broker in the market has several clients who deal through him. Now the broker wants to increase the sales volume of some set of securities. For that, he decided to sell the security to his client at a lower price than the selling price or the highest bid pricesBid PricesBid Price is the highest amount that a buyer quotes against the “ask price” (quoted by a seller) to buy particular security, stock, or any financial instrument. read more among the brokers in the securities market. He sold the shares of A ltd company at $ 35 per share to his clients. On the other hand, he purchased the same stock in the broker market at a high price of $ 50 per share. Discuss the spread which arises due to the price difference between the selling price to the clients of the security and buying price of the same security from the broker market.

In the present case, a broker wants to increase the sales volume of some set of securities. For that, he decided to sell the security to his client at a lower price than the highest bid prices among the brokers in the securities market. And for that, he sold the shares of A ltd company at the price of $ 35 per share to his clients, which he bought from the broker market at the high price of $ 50 per share. As a result, there is a negative spread between the selling price to the security clients and the buying price of the same security from the broker market. Therefore, Markdown on shares that the broker sells is – $ 20 ($ 35 – $ 50).

Example #2

A dealer thought that the demand for the municipal bondMunicipal BondA municipal bond is a debt security issued by a national, state, or local authority to finance capital expenditures on public projects related to the development and maintenance of infrastructures such as roads, railways, schools, hospitals, and airports.read more  issue would be very high in the market, but the actual demand was not as much as the dealer thought it to be. So, the broker might be forced to sell at a lower price to clear its inventory. The difference arising due to the lowering of the prices is the markdown.

Example #3

There is a broker who deals in securities. He believed that by reducing the prices of a security for the clients, he could generate profits through the commission, which are enough to make up for the loss, which could arise due to the lower prices. So he reduced the prices of the securities, and this reduction is known as Markdown.

Advantages

Disadvantages

The regulators consider the markups and markdowns of more than 5 % excessive, but this is only the guideline and not the rule.

Important Points of Markdown

  • It is not required to disclose the markups and the markdowns in the principal transactions, so the investor can easily be unaware of differences in the price. The principal transaction occurs in case the dealer sells the securities out of his own account at his own risk.The range of markdowns between 5% – 10% is justifiable based on security type, prevailing market conditions, or the broader dealer pattern of markups and markdowns.Undisclosed spreads, the percentages of which are over 10 %, are to be considered fraudulent.The Markdown and the markup are two different terms having different meanings and should not be confused. Suppose the spread is positive, which arises between the prices the dealer charges from its retail customer for the particular security with prices on the inside market. In that case, it is known as the markup, and if the spread is negative, it is known as the Markdown.

Conclusion

Thus it can be concluded that Markdown is a difference or spread that arises between prices that the dealer charges from its retail customer for particular security with prices on the inside market if the spread is negative. Sometimes, the dealer offers lower prices to stimulate trading with the main idea of making extra money through the additional commission on increased sales.

This article has been a guide to markdown and its definition. Here we discuss the examples of Markdown along with advantages and disadvantages. You can learn more about accounting from the following articles –

  • Formula of Markup PercentageWhat is Money Market Account?Calculation of Market CapitalizationMargin vs. MarkupClayton Antitrust Act