SIE EXAM - Section #1 (Capital Markets)

SEC

Securities & Exchange Commission

SEC Use

A US government oversight agency to protect market participants (investors) & to cultivate fair & efficient markets

SEC in relation to US gov

US gov oversight agency

o   Works alongside self-regulatory agencies, state regulators, & Congress

SEC EST

1934 POST Great Depression

4 Legislations passed by Congress & overseen by SEC

1. Securities Act of 1933

2. Securities Exchange Act of 1934

3. Investment Advisers Act of 1940

4. Investment Company Act of 1940

Securities Act of 1933

Regulates IPOs & requires issuers (companies) to disclose important information to investors (prospectus) & registration of new securities with SEC

Securities Act of 1933 REQs

1. companies must register new securities with SEC

2. investors must get a prospectus with key info

Securities Act of 1933 - Delivery date

SEC mandates a prospectus to be must be delivered at or before the confirmation of sale

Prospectus Definition

a legal doc filed with the SEC about an investment offering that must be delivered before or at the time of sale

Prospectus REQs

1. company profile (business description, operations, products/services)

2. MGT team (name, bio, compensation)

3. Financial Statements (historical & current data)

4. offering details (type of sec, offering price, number of units, authorized/outstanding shares)

5. use of proceeds (how capital will be used by company)

6. risk factors (potential risks to the investment)

7. fees & terms (applicable costs & transaction details)T

Types of Prospectuses (5)

1. Preliminary (RED HERRING)

   1. initial version filed w/ SEC before offering is effective

   2. omits final price & number of shares

2. Final

   1. complete, approved with all details, issued after SEC approval

3. Shelf

   1. allows registration of securities for up to 3 years

   2. continually updated with supplementary findings

4. Fund

   1. mutual funds/ETFs

   2. detailing objectives, strategies, risks, fees, & performance

5. Summary

   1. condensed; highlights key facts

Securities Exchange Act of 1934

Regulates trading in the secondary market & enforces rules against fraud/market manipulation

Securities Exchange Act of 1934 PERODIC REPORTING REQS

issuers with over $10 million in assets & their securities are held by more than 500 owners

Secondary Market

facilitates transactions in securities that are NOT sold directly by issuer

• investors purchase from other investors in the mkt, usually through trading accounts held by brokerage accts (ex. Fidelity & Charles Schwab)

Investment Advisers Act of 1940

Regulates investment advisers (prohibits advertising that is “fraudulent, deceptive, & manipulative) & requires to act in their clients’ best interests. Designated terms “accredited investor” & “qualified client” (may be charged excess fees by registered investment advisers)

Accredited Investor

individual/couple with net worth >$1 million or earned in excess $200K/$300K for 2 successive years

Qualified Client

Must meet 1/5 criteria

1. Assets Under MGT

   1. >$1.4 million in assets

2. Net Worth

   1. >$2.7 million at time of advisory agreement

3. Qualified Purchaser Status

   1. own $5 million+ in investments

4. Executive or Knowledgeable Employee of the Adviser

5. Excess SEC criteria

Investment Company Act of 1940

Regulates organization of companies like mutual funds & unit investment trusts to ensure they operate fairly & transparently

Investment Company Act of 1940 Goal

reduce conflict of interests by requiring disclosure.

• Includes

  • financial condition

  • investment policies

  • information about the fund

  • investment objectives

  • investment company structure & operations

DOES NOT give SEC direct authority to supervise investment decisions/judge merits

Investment Company Act of 1940 - Sec. 22

requires redemption price to be based on daily computation of net asset value & reqs redemptions to be paid within 7 days

• SEC requires 85% of investment company assets to be in liquid securities

Redemption Price

amount an issuer pays to repurchase a security from the investor (at or before maturity)

Self-Regulatory Organizations (SROs)

A non-governmental organization that has the authority to regulate its own members, subject to oversight by the SEC. Its purpose is to protect investors and ensure fair markets by creating and enforcing industry rules, monitoring compliance, and disciplining members who violate regulations.

Ex. of SROs

1. NYSE

2. CBOE

3. FINRA

4. MSRB

New York Stock Exchange (NYSE)

• Type of SRO

• created in 1792 - largest stock exchange in the world

  • rigorous process to be listed & stay listed

Chicago Board Options Exchange (CBOE)

• 1973 - largest options exchange in the world

FINRA

• supervised by SEC, not-for-profit org to oversee broker-dealers

  • authorized by Congress to write rules/procedures & enforce in efforts to protect investing public

Municipal Securities Regulatory Board (MSRB)

writes & enforced rules for investment firms/banks who sell municipal bonds, notes, & other municipal securities

Other Regulators

o   US Treasury

o   Internal Revenue Service (IRS)

o   The Federal Reserve (The FED)

o   State Regulators

o   Federal Deposit Insurance Corporation (FDIC)

o   Securities Investor Protection Corporation (SIPC)

o   Foreign Country Regulators

US TREASURY

created to manage government revenue

• oversee IRS

• created FinCEN as a bureau

IRS

collected taxes & administers tax law reqs. by Congress

• also a treasury bureau

The FED

• central bank of US

• duties:

  • Maximize employment

  • stabilize prices

  • moderate long-term interest rates

  • regulate banks

  • maintain financial system’s stability

  • provide financial services to depository institutions

State Regulators

protect investing public from fraud (each state has their own)

FDIC

independent gov agency that provides deposit insurance to US bank depositors

SIPC

insures eligible investors in cash to their brokerage accounts

Foreign Country Regulators

most companies have their own gov. agencies like the SEC

Market Participants: Retail Investors

individual investors who buy/sell public debt/equity securities using their own money through their retirement/brokerage accounts for their own personal gain

****SEC sees them as unsophisticated → most regulations are targeted at protecting this class****

Market Participants: Accredited

must meet certain requirements to be considered with this distinction

• can be an individual OR entity

• can trade in private securities not registered with SEC

Criteria: net worth >$1,000,000 OR excess income of $200K/$300K in 2 successive years

Market Participants: Institutional

ONLY LEGAL ENTITIES

• trade securities on behalf of shareholders & buy/sell in large quantities

considered experiences/sophisticated so les regulations

Broker Definition

entity that trades securities on behalf of its clients D

Dealer/Principal Definition

trades on behalf of itself

Types of Broker-Dealers

1. introducing

2. clearing

3. prime brokers

Types of Broker-Dealers: Introducing

• DO NOT hold client funds/execute transactions

• receive orders but must contact a clearing firm to process

Types of Broker-Dealers: Clearing

hold customer accounts & responsible for clearing trades & ensuring those trades reach settlement

Types of Broker-Dealers: Prime Brokers

ONLY service large financial institutions as a way for them to outsource certain activities (trade clearing, settlement, risk/performance analysis)

Investment Advisers

Fiduciaries who are registered with state regulators and/or the SEC to provide advice to clients about securities investments, manage investment portfolios, or other financial planning/brokerage services

*individual - investment adviser representative*

Issuer

legal entities that fund their operations by selling securities to investors

Underwriter

facilitate the sale & distribution of an issuer’s securities by pricing securities, purchasing securities directly from the user, and then finally selling the securities to the investors.

Trader

brokerage firm which engages in providing day-to-day availability for public investors who wish to buy/sell stocks & bonds

Market Makers

goal is to maintain liquidity so they will buy/sell securities of a defined set of companies to broker-dealers who are members of the exchange

Trustee

an individual, broker, bank or similar org charged with governing a trust fiduciary duty

Custodian

the entity that actually holds the assets for safekeeping

Transfer Agent

bank or trust company that as an intermediary between securities issuers & securities holders → goal = maintain security holder records & distribute dividends on behalf of the issuing company (req to be registered by SEC)

Depository Trust & Clearing Corporation (DTCC)

manages daily clearing & settlement processes for most securities transactions in the US

• like a check… purchase isn’t ‘good’ until cleared by the DTCC

Types of Markets: Primary Market

where NEW debt & equity securities are issues for the first time

Types of Markets: Primary Market Purpose

to raise capital for issuers (gov/company)

Types of Markets: Primary Market Key Players

investment banks (underwriters) & issuers

Types of Markets: Primary Market Key Features

1. money flows from investors → issuers

2. NO trading of securities between investors

Types of Markets: Secondary Market

where EXISTING securities are traded between investors (aka stock market)

Types of Markets: Secondary Market Purpose

provide liquidity (buy/sell AFTER issuance - IPO)

Types of Markets: Secondary Market Key Players

NYSE, NASDAQ

Types of Markets: Secondary Market Key Features

1. issuer does NOT receive money

2. money flows between investors ONLY through trading accounts held by brokerage firms (Fidelity/Charles Schwab)

Types of Markets: Third Market (OTC)

OTC trading of exchange-listed securities between institutional investors & broker-dealers

Types of Markets: Third Market Purpose

provides a decentralized way to trade securities through dealers instead of a central exchange

Types of Markets: Third Market Key Players

broker-dealers

Types of Markets: Third Market OTC Key Features

1. able to bypass broker fees & the involvement of formal exchanges like NYSE

2. dealers hold inventory & quote prices (market makers selling inventory)

3. Dealer = principal, Trades at bid & ask prices

Types of Markets: Third Market NON-OTC

OTC of exchange listed securities

Types of Markets: Fourth Market

direct trading between institutions

Types of Markets: Fourth Market Purpose

trading of securities directly between large institutional investors, bypassing exchanges and brokers, typically using electronic networks to reduce costs and increase efficiency.

Types of Markets: Fourth Market Key Players

large institutions

Types of Markets: Fourth Market Purpose

Types of Markets: Fourth Market Features

• no brokers or dealers

• occurs after hours & does not carry any reporting material

• retail investors NOT permitted

• Electronic communication networks (ECNs)

  • reduce cost & increase efficiency

  • very large block trades

Foreign Markets

provide investors with access to international securities, usually riskier than US securities

American Depositary Receipts (ADRs)

certificates that represent shares of a foreign company’s stock (trade on stock exchange in US & priced in US dollars)

Regulation S Offerings

offering of securities by a US or foreign corp where the offering takes place outside the US & only non-US investors participate

exempt from SEC regulations

Monetary Policy

actions taken by the Fed to promote/maintain the health of the US economy (separate from Congress & POTUS)

Federal Open Market Committee (FOMC)

Under the Fed; meets 8 times/year to review economic conditions & evaluate policy changes

• most common change = inc/dec federal funds rate

Fiscal Policy

actions taken by Congress/POTUS in setting tax rates & policies

Fed economy stimulation

increase available lendable money supply at banks → decline in bank interest rates → more spending by consumers

3 Types of Rates

1. Prime

2. Discount

3. Federal Funds

Prime Rates

base interest rate offered by commercial bank for consumer loans (direct relationship with DR)

Discount Rate

rate offered to member banks who borrow money from the Fed to keep their reserves up

Federal Funds Rate

target rate set by Fed to control inflation

Balance Sheet

details company’s assets, liabilities, & SE at a SPECIFIC POINT IN TIME

• guages overall company health

Income Statement

company’s revenues & expenses OVER A PERIOD OF TIME

• NI = total rev - exp

Statement of Cash Flows

company’s cash inflows & outflows (3 sections)

3 Sections of S of CF

1. operating activities

2. CF from investing

3. CF from financing

Stockholders’ Equity Statements

changes in a company’s equity accounts over a SPECIFIC PERIOD OF TIME

Business Cycle

1. expansion

2. peak

3. contraction (recession)

4. trough

5. recovery

Expansion

growing economy; healthy GDP (2/3%)

Peak

economy is overheated; prices hit their highest level & economic indicators stop growing

Contraction (recession)

GDP falls below 2%

• Less than 2% for 2+ consecutive quarters = recession

  • more layoffs & unemployment increases, hard to secure credit

Trough

economy reaches lowest point before contraction phase to recovery

Recovery

low prices help foster demand (unemployment decrease & productivity increase)

Economic Indicators

1. leading

2. lagging

3. coincident

Economic Indicators: Leading

where economy is headed in SR (next phase of business cycle)

Lagging

reveals trends AFTER events (most prominent = unemployment)

Coincident

stats that tells analysts how the economy is currently doing

Effects on Bonds & Equity Mkts

1. cyclical

2. defensive

3. growth

Effects on Bonds & Equity Mkts - Cyclical

follows standard business cycle (does well in good economy, bad in poor → leisure/luxury)

Effects on Bonds & Equity Mkts - Defensive

makes goods we use in daily lives but are not impacted by how economy is doing (ex. basic food, public utilities, soap)

Effects on Bonds & Equity Mkts - Growth

industries expected to grow faster than the economy in general (tech, healthcare, biomedical)