Unit 8 - Trading Securities

8.1 - secondary market basics

Secondary Market

aftermarket where investors buy and sell to each other apart from the issuer. Exchanges, such as Nasdaq, NYSE, and NYSE American, facilitate the secondary market

Note - If there were no secondary markets, there would be very little or no primary market. If there were no primary market, it would be much more difficult to grow a business and enjoy the economic expansion and job growth that go with a growing economy.

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Trading of securities in the secondary market is regulated under the...

Securities Exchange Act of 1934

The act of 1934 created the....

SEC

(4) market centers in the US that make up the secondary market

1. Exchanges

2. Over-The-Counter (OTC) market

3. The third market

4. The fourth market

Take Note

In the primary market, the issuer is the seller. In the secondary market, investors buy and sell securities. Issuers are rarely involved in the secondary market.

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The best known exchange is the...

New York Stock Exchange (NYSE)

Most exchanges maintain a physical location called the

Trading Floor

Trading on an exchange is done between the

members of the exchange.

Exchanges do have employees, but...

they support the exchanges, they don't do them

Who are the exchange member firm employees who execute trades?

Floor Brokers

Whose job is it to maintain inventory of their assigned securities, facilitate trades, and buy/sell from their inventory to keep markets balanced?

Designated Market Makers (DMMs)

Stocks that trade on an exchange are called...

Listed Stock

Your customer enters a trade to sell 100 shares of ABC Corporation. Where will this trade take place?

A)

The money market

B)

The secondary market

C)

The principal market

D)

The primary market

B

Which of the following is not a member of an exchange?

A)

A two-dollar broker

B)

A designated market maker

C)

A floor broker

D)

A senior manager of the exchange

D

8.2 - Over the counter market and other market centers

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Over the Counter Market (OTC)

a decentralized, off-exchange financial marketplace where securities—such as stocks, bonds, derivatives, and foreign exchange—are traded directly between two parties without a centralized exchange like the NYSE or Nasdaq.

Securities that trade OTC are called

Non-listed securities or unlisted securities

Trades in the OTC are between

specialized broker-dealers called market makers

There are multiple market makers for a given stock, which means...

they compete for business

When an investor buys an OTC security, they are buying from...

a market maker

When an investor sells an OTC security, they are selling to...

a market maker

A broker-dealer may assist a customer in a trade by...

identifying a market maker that will be able to provide the trade the customer needs.

A broker-dealer that assists the customer is acting as an...

agent, representing the customer in the trade. They will charge a commission for this service.

A broker-dealer may not act as both...

the agent and a market maker on the same trade.

The Third Market

Known as the Nasdaq intermarket. When exchange-listed securities are traded on the OTC

- All securities listed on the NYSE and most listed on regional exchanges are eligible for OTC trading in the third market

The Fourth Market (The ECNs)

a market for institutional investors in which large blocks of stock are traded, generally with other institutional investors without the assistance of a broker-dealer

4th market transactions take place through

Electronic Communication Networks (ECNs)

ECNs are open...

24 hours a day

4th market exchanges are often called ____ _____ because they are less transparent due to them not being made public until after the trade is complete

Dark Pools

When a broker-dealer maintains an inventory in a particular stock and trades that stock in the OTC market, it is acting as

A)

an underwriter.

B)

a market maker.

C)

an agent.

D)

a broker.

B

A large-volume transaction for an institutional investor has occurred on an alternative trading system or network. Entered anonymously, the general public will see no information regarding the volume, price, or identity of the institutional investor. This transaction scenario is generally referred to as having occurred

A)

in the third market.

B)

on a U.S. exchange.

C)

in the over-the-counter market.

D)

in a dark pool.

D

8.3 - Participants in the Secondary Markets

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Retail Investors

the normal people who are investing their own money to accomplish their own objectives

Day Trader

a type of retail investor that trades rapidly in and out of positions.

Accredited Investors

This classification is used in primary market transactions, particularly for Regulation A and Regulation D private placements. The term has no specific use in secondary markets, but it may be used to identify a wealthier or more sophisticated retail investor.

Institutional Investor

a large investor like a mutual fund, pension fund, bank, insurance company, or some other financial organization.

Fiduciary

a person who manages assets (usually financial) for another person, the beneficiary. Fiduciaries have a legal and moral obligation to perform their duties in the best interest of the beneficiary, placing the beneficiary's interest before their own.

"Custodians" is a term referred to (2):

those who manage a minor's account

A firm that holds assets in a retirement account

The (3) prong test for who is an Investment Advisor:

1. Gives investment advice

2. Provides this advice as a regular part of their business

3. Does so for compensation and is registered under the Investment Advisors Act of 1940

Broker Dealers

perform securities transactions. Earn revenue from transactions fees. Members of FINRA

Carrying Firms

also known as clearing firm, carries accounts and accepts funds and securities from customers. Among the larger BDs. Can execute trades, clear and settle transactions, take custody of customer funds and securities

Ex. Vanguard

T or F? A carrying firm must segregate (hold separately) customer funds and securities. They may not combine the firm's assets with client assets.

True

Fully Disclosed Firm

uses a carrying/clearing firm to handle customer accounts and trade settlements

Prime Account

Allows a customer (generally an institution) to select one member firm (the prime broker) to provide custody & other services, while the other firms (called executing brokers) handle all the trades placed by the customer.

The key advantage of a prime brokerage account is...

that it usually provides a client with the ability to trade with multiple brokerage houses while maintaining a centralized master account with all of the client's cash and securities

Transfer Agents

maintains a count of the total number of shares of a company that are authorized and outstanding. The transfer agent for a corporation is also responsible for

Registrar

Licensed by the states to provide audit and oversight services for the transfer agents

Clearing Agency

intermediary between the buying side and selling side. Ensures trades are settled correctly

An investor that trades frequently within a day and closes most of their positions by the end of the trading day is

A)

a prime broker.

B)

a day trader.

C)

an accredited investor.

D)

an institutional trader.

B

A broker-dealer that holds customer funds and securities is

A)

an introducing firm.

B)

a carrying firm.

C)

a regional firm.

D)

a fully disclosed firm.

B

A transfer agent is responsible for all of the following activities except

A)

canceling old and issuing new certificates.

B)

ensuring that its securities are issued in the correct owner's name.

C)

settling trades.

D)

maintaining records of ownership.

C

8.4 - Placing a trade

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A quote on a given security has two sides:

bid and ask

Most quotes provide size, which is...

the number of shares someone is willing to buy at the bid

Round Lots are units of...

100 shares. The typical unit that size is expressed in for a quote

Bid

the highest price someone is currently willing to pay for the security

Example

BCO stock is bid 42, size 10.

This means....

there is a buyer (maybe multiple buyers) willing to buy up to 1,000 shares of BCO at $42 per share. If your customer wants to sell some BCO stock, they know that they could sell as many as 1,000 shares at $42 per share.

Ask

also known as the offer, is the lowest amount someone is currently willing to sell the security for

Example

BCO stock is ask 42.5, size 12.

This means...

there is someone (maybe multiple persons) willing to sell as many as 1,200 shares of BCO at $42.50 per share. If your customer wants to buy some BCO stock, they know they can buy as many as 1,200 shares at $42.50 per share.

Spread

the difference between the bid and ask prices

Example

ABC is quoted Bid 42 Ask 42.5. The spread is.....

50 cents

Who maintains the order book?

Designated Market Maker

On an order book, the highest buy limit =

the most that someone will pay for the stock and establishes the bid

On an order book, the lowest sell limit =

the least someone will sell their stock at and establishes the ask

Bonds trade in the OTC market and the process is the same, but remember that bonds are quoted as a...

percentage of par

the highest bid is called the....

Inside Quote

The lowest ask is called the...

Inside Market

Your customer believes that LMN Corporation stock is about to increase in value quickly. Their attitude towards LMN can be called

A)

bullish.

B)

bearish.

C)

catish.

D)

dogish.

A

BigCo is currently quoted bid 32 ask 32.5 10 × 12. Your customer may be able to buy

A)

1,200 shares at $32.50 per share.

B)

1,000 shares at $32.50 per share.

C)

1,000 shares at $32 per share.

D)

1,200 shares at $32 per share.

A

ABC stock is quoted at 25.20 bid — ask 25.22 5 × 12. The spread is

A)

$0.02.

B)

$0.25.

C)

$0.12.

D)

$0.20.

A

8.5 - Types of Orders

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Market Order

the most common type of order, when someone simply wants to buy/sell at the current market price

Market orders have no restriction and have...

priority over orders with restrictions

for Market Orders, the customer won't know the price until....

the order is filled

Example

The quote on KPN stock is Bid 25 Ask 25.25.

A market order to sell KPN stock will be filled as soon as it reaches the market. The most likely price will be $25 per share, but that number might be lower or higher depending on how fast the market is moving.

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Limit Order

customer specifies a price that is acceptable to them

In a limit order, the customer is GTD the...

limit price or better, but a trade is not GTD

Example

BCO stock is trading at $42. The customer enters a sell limit at $44. Nothing happens until the stock moves to or above $44. Then the customer's sell order will begin to be filled as long as there are buyers at $44 or better

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a Stop Order is essentially

"if the price moves to or past X, enter an order to do Y"

When the CMV of the stock moves to or through the trigger price, the stop order becomes...

a market order

Sell stops are used to sell a stock once...

price starts to move downward

Sell stops have a trigger price that is....

BELOW current market price

Buy stops are used to buy a stock once...

price starts to move upward

Buy stops have a trigger price that is...

ABOVE current market price

Example

BigCo, Inc., (Ticker BCO) common stock is trading at a CMV = $12.

Order: Buy 2,000 shares BCO at 15 stop.

As soon as BCO trades to or through the stop price of 15, this order will become a live working market order, and like all market orders, it will be executed immediately at the next available price.

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Day Order

valid until the close of trading on the day it is entered

- if the order is not filled, its canceled

Good-till-canceled (GTC) order

an order that is left on the books until it is either executed or canceled

Fill-or-kill (FOK) order

an instruction to fill the entire order immediately or kill (cancel) the order completely

Immediate-or-cancel (IOC) order

like fill-or-kill (FOK) except a partial execution is acceptable

All-or-none (AON) order

must be executed in their entirety or not at all

Only difference between All-Or-None (AON) and Fill-Or-Kill (FOK) is...

AONs don't need to be filled immediately

A customer enters an order to buy 100 shares of KPN, Inc., stock with no other restrictions. This is an example of which of the following?

A)

Market order

B)

Buy stop limit order

C)

Buy stop order

D)

Limit order

A

A customer enters an order to buy 100 shares of KPN, Inc., stock at 45. The trade can be executed at any of the following prices except

A)

$45.00.

B)

$32.00.

C)

$44.50.

D)

$45.05.

D

A customer enters an order to sell 100 shares of SCO, Inc., stock with a stop price of $45. Once elected, the order may be filled at which of the following prices?

A)

$46

B)

$44

C)

$45

D)

Any price

D - Once a stop price has been triggered (elected), it becomes a market order. Market orders can fill at any price. Any price is the best answer

A customer enters an order to purchase 10,000 shares of ABC Corporation stock at a limit of $75. They would like the order to stay open until filled, even if it takes several days. This order should be entered as which of the following?

A)

Day order

B)

Stop order

C)

GTC order

D)

This order is not allowed.

C

8.6 - Positions

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Long Selling

When an investor buys a security, they have taken a long position in that security, meaning they now own the security.

- Bullish

- Risk = the price could fall

- Maximum loss = price falls to 0

A long Seller ___ to open, ___ to close

buys, sells