Series 65 Unit 23 Trading securities

cash accounts

pay in full for securities

personal retirement accounts (IRAs)

corporate retirement accounts

custodial accounts (UTMAs)

Coverdell ESAs

margin accounts

borrow money for investing

margin: minimum deposit for buying securities

leverage: potential for gain/loss using borrowed funds

marginable securities: exchange-listed stocks/bonds, Nasdaq stocks, warrants

non-marginable securities: options, stock rights, insurance contracts

margin collateral after 30 days: mutual funds, new issues

documentation: credit agreement, hypothecation agreement, optional loan consent

credit agreement: terms of credit, collateral use

hypothecation agreement: pledge securities to lender

loan consent: lend securities to other brokers (optional)

maintenance

SROs set minimum equity levels in margin accounts

margin maintenance call: request for additional funds

current SRO level: 25% for long margin accounts

example: $8,000 market value, $6,000 debit balance, $2,000 equity (25%)

if equity drops below 25%, maintenance call issued

broker-dealer can liquidate securities to meet maintenance level

house maintenance

stricter limits by broker-dealers

higher minimum equity levels (e.g., 35%+)

stricter than SRO maintenance level (25%)

mixed margin account

short sales in margin accounts

mixed margin account: long and short positions

long equity: CMV long - debit balance

short equity: credit balance - CMV short

net equity: add positives (stock owned + credit balance), subtract negatives (cost to buy back short stock + debit balance)

positive (negative) margin

positive margin: returns > cost of borrowed money

example: $10,000 stock, 50% margin, $400 interest, $11,000 sale, $600 net profit

negative margin: cost > returns

margin interest: tax-deductible (except for municipal securities)

deductible interest: up to portfolio income (interest, dividends, capital gains)

securities markets

primary market: proceeds go to issuer

secondary market: previously issued securities bought/sold

major exchanges: NYSE, NYSE American, CBOE, NASDAQ

OTC market: broker-dealer network for unlisted securities

exchange market: listed securities traded on exchanges

SEC powers: suspend trading (nonexempt securities up to 10 days, entire exchange up to 90 days)

location: central marketplaces (e.g., NYSE), electronic markets (e.g., NASDAQ)

pricing system: auction markets on exchanges

specialist: maintains orderly market, minimizes price disparities

OTC market: interdealer market, no central marketplace

pricing system: negotiated market, market makers post bid/ask prices

market makers: buy/sell securities, act as dealers

dual capacity of a broker-dealer

brokers act as agents for clients

brokers find buyers or sellers for clients

brokers charge a commission

brokers do not hold inventory

dealers act as principals in trades

dealers buy and sell for their own account

dealers hold inventory

dealers sell from inventory to buyers

dealers buy for inventory from sellers

carrying versus introducing broker-dealers

carrying firms hold customer accounts, funds, and securities

carrying firms provide clearing and settlement functions

carrying firms face more risk and need greater net capital

introducing firms do not hold customer funds or securities

introducing firms outsource back-office functions to carrying firms

clearing firms handle confirmations, statements, and other tasks

introducing firms focus on core activities

clearing agreements specify responsibilities for both parties

trading costs

brokers charge commissions for buying and selling securities

commissions are added to purchase price or deducted from sale proceeds

dealers charge markups when selling from inventory

dealers charge markdowns when buying for inventory

firm quote includes bid (highest buy price) and offer (lowest sell price)

spread is the difference between bid and offer

more active stocks have narrower spreads

quote size indicates number of shares available at quoted prices

Practice Question

When viewing several of your client's trade confirmations, you notice that a recent purchase was made of ABC stock where there was no commission indicated, while a sale took place of DEF stock in which the commission listed was $55. From this information you could determine that

I. ABC was purchased in an agency transaction.

II. ABC was purchased in a principal transaction.

III. DEF was sold in an agency transaction.

IV. DEF was sold in a principal transaction.

A. I and III

B. I and IV

C. II and III

D. II and V

Answer: C. Whenever a trade is made without a commission indicated on the confirmation, it means that a markup or markdown was charged. That makes it a dealer or principal transaction. Commissions are always disclosed on agency transactions. Therefore, we know that ABC (II) was purchased in a principal transaction and DEF (III) was sold in an agency transaction, so the correct match is choice C.

Practice Question

If WXYZ is quoted as 43.25 to .50, it means that the bid price (the price that a customer would receive for her shares) is $43.25, and the ask price (the price that the customer would pay to buy shares) is $43.50. The $.25 difference is the dealer's spread. Alternatively, the exam might put it like this:

A broker-dealer quotes a stock 42 to a half. The difference between these two numbers is known as

A. the broker's commission.

B. the dealer's markup.

C. the profit margin.

D. the spread.

Answer: D. The dealer's quote represents the bid and the offer (ask) prices. This quote is 42 bid and 42.50 offered. The difference between these two is the spread. Markup is added to the higher price (the ask or offering price).

order (trade) ticket

account number

order type: solicited, unsolicited, or discretionary

sale type: long or short

order terms: market, limit, or stop

number of shares or bond par value

time of order entry

broker-dealer name and responsible registered individual

order types

market order: executed immediately at market price

limit order: limits amount paid or received

stop order: becomes market order at stop price

stop limit order: becomes limit order at trigger price

day order: expires end of day if not filled

good till canceled: remains until filled or canceled

short sale: selling borrowed stock, requires margin account

stop order: protects profit or prevents loss, becomes market order at stop price

stop limit order: becomes limit order at trigger price

Practice Question

Which of the following types of orders does not restrict the price at which an order is executed?

A. Limit

B. Stop

C. Market

D. Stop limit

Answer: C. A market order does not reflect or restrict the price at which a security is executed. A limit order limits the amount to be paid or received for securities. A stop order becomes a market order if the stock reaches or goes through the stop price. A stop limit order becomes a limit order if the stock hits or goes through the trigger price.

Practice Question

A client order is received with the following instructions: Buy stop 100 shares ABC at 34, limit 34.20. After the order is submitted, trades occur at 33, 33.90, 34.10, 33.85, 34.05, and 34.25. More than likely, the client paid

A. 33.85.

B. 34.05.

C. 34.10.

D. 34.25.

Answer: A. This is two orders in one. The first does not become triggered until the price gets as high at 34. That happens at 34.10. Once triggered, a buy limit order at 34.20 is entered (pay 34.20 or less), and the trade at 33.85 meets that requirement.

market manipulation

capping: entering sell orders to keep stock price from rising (short position)

supporting: entering buy orders to keep stock price from falling (long position)

pegging: any activity to keep stock price from moving (buy or sell orders)

block trade

block: at least 10,000 shares or $200,000 USD

for stocks under $20, 10,000 shares is a block

for higher-priced stocks, 1,000 shares can be a block

high frequency trading

HFT: dominant trading form, over half of us equity volume

HFT: autonomous computerized trading for quick profits

HFT: uses high-speed connections, trades at near light speed

regulators debating HFT impact on market efficiency and stability

flash crash (May 6, 2010) partly due to HFT

HFT: captures minute price discrepancies, trades in large volumes

benefits: increased liquidity, market efficiency, reduced costs

negatives: market manipulation, disadvantages small investors, snowballing effect