Securities Industry Essentials: Markets, Products, Rules and Regulations

SEC (Securities and Exchange Commission)

The primary federal regulatory body for the securities industry, created by the Securities Exchange Act of 1934.

SRO (Self-Regulatory Organization)

An entity accountable to the SEC that regulates its own members to promote fair trading practices (e.g., FINRA, CBOE, MSRB).

Primary Market

The market where newly issued securities are sold to the public for the first time, usually through an IPO.

Secondary Market

The market where previously issued securities are bought and sold between investors (e.g., NYSE, Nasdaq).

Fiscal Policy

Government actions concerning taxation and spending, managed by the President and Congress.

Monetary Policy

Actions taken by the Federal Reserve to control the money supply and interest rates to influence the economy.

Common Stock

An equity security representing ownership in a corporation, providing voting rights and potential for capital appreciation and dividends.

Preferred Stock

An equity security with a fixed dividend that has priority over common stock in the event of corporate liquidation.

Statutory Voting

A voting method where a shareholder gets one vote per share owned for each directorship being voted on.

Cumulative Voting

A voting method that allows shareholders to pool their votes and allocate them as they wish, benefiting minority shareholders.

ADR (American Depositary Receipt)

A certificate issued by a U.S. bank representing a specified number of shares in a foreign stock, traded on U.S. exchanges.

Treasury Bill (T-Bill)

A short-term U.S. government debt obligation with a maturity of one year or less, issued at a discount to par and paying no semi-annual interest.

Municipal Bond

A debt security issued by a state, municipality, or county to finance capital expenditures. Interest is typically exempt from federal taxes.

General Obligation (GO) Bond

A municipal bond backed by the full faith, credit, and taxing power of the issuing municipality.

Revenue Bond

A municipal bond backed by the income generated from the specific project the bond is funding (e.g., a toll bridge or hospital).

Call Option

A contract giving the buyer the right to BUY the underlying security at a specified strike price before expiration.

Put Option

A contract giving the buyer the right to SELL the underlying security at a specified strike price before expiration.

Mutual Fund (Open-End Fund)

An investment company that continuously issues and redeems shares based on Net Asset Value (NAV), offering a diversified portfolio.

ETF (Exchange-Traded Fund)

An investment fund traded on stock exchanges throughout the day, much like stocks, that generally tracks an index.

Systematic Risk

The risk inherent to the entire market or market segment that cannot be mitigated through diversification (e.g., market risk, inflation risk).

Non-Systematic Risk

Risk specific to a single company or industry that can be reduced through diversification (e.g., business risk, regulatory risk).

Market Order

An order to buy or sell a security immediately at the best available current price.

Limit Order

An order to buy or sell a security at a specific price or better.

Stop Order

An order that becomes a market order once the security reaches a specified price; often used to protect gains or limit losses.

T+1 Settlement

The standard settlement cycle for most equity and corporate bond trades, meaning the trade settles one business day after execution.

Margin Account

A brokerage account in which the broker-dealer lends the customer cash to purchase securities, using the securities as collateral.

Regulation T (Reg T)

The Federal Reserve Board regulation that governs customer cash accounts and mandates a 50% initial margin requirement for purchasing securities.

Churning

The prohibited practice of excessive trading in a customer's account by a broker solely to generate commissions.

Front-Running

The illegal practice of a broker executing orders for their own account while taking advantage of advance knowledge of pending customer orders.

Insider Trading

The illegal trading of a company's securities by individuals with access to material, non-public information.

Form U4

The uniform application used to register securities professionals with FINRA and other SROs.

Form U5

The uniform termination notice filed by a broker-dealer when a registered representative leaves the firm. Must be filed within 30 days.

SIPC (Securities Investor Protection Corporation)

A nonprofit corporation that protects investors up to $500,000 (including $250,000 for cash) if a brokerage firm goes bankrupt.

Wash Sale Rule

An IRS rule prohibiting an investor from claiming a capital loss on the sale of a security if they purchase a "substantially identical" security within 30 days before or after the sale.

Q: What is the maximum penalty for an individual convicted of insider trading?

A: Up to 20 years in prison and a fine of up to $5 million.

Q: What is the difference between a broker and a dealer?

A: A broker acts as an agent executing trades for clients for a commission; a dealer acts as a principal trading from its own inventory for a markup/markdown.

Q: What happens when a corporate bond is "called"?

A: The issuer redeems the bond before its maturity date, usually during periods of falling interest rates, so they can refinance at a lower rate.

Q: Under FINRA rules, how long must a broker-dealer retain customer complaints?

A: 4 years.

Q: What is the "cooling-off period"?

A: A minimum 20-day period following the filing of a registration statement with the SEC, during which no sales of the new security can take place.

Q: What is the purpose of a preliminary prospectus (Red Herring)?

A: To gauge investor interest during the cooling-off period; it contains a range for the offering price but no exact price or effective date.

Q: How often must a broker-dealer send customer account statements for active accounts?

A: Monthly. (Inactive accounts receive them quarterly).

Q: What does the Customer Identification Program (CIP) require?

A: Under the USA PATRIOT Act, financial institutions must verify the identity of individuals opening an account to prevent money laundering and terrorism financing.

Q: What is the difference between Defensive and Cyclical stocks?

A: Defensive stocks remain stable during economic downturns (e.g., utilities, basic food), while Cyclical stocks follow the business cycle (e.g., auto, travel, luxury).

Q: What is the formula for Current Yield on a bond?

A: Annual Interest Payment divided by the Current Market Price.

Q: What is "Free-Riding"?

A: The prohibited practice of buying a security and selling it before fully paying for the initial purchase. The account will be frozen for 90 days.

Q: If interest rates go up, what happens to the price of existing bonds?

A: Bond prices go down. Interest rates and bond prices have an inverse relationship.

Q: What is a firm commitment underwriting?

A: The underwriter agrees to purchase the entire issue of securities from the issuer and absorb any securities that are not sold to the public.

Q: How long is the FINRA Regulatory Element Continuing Education requirement?

A: It must be completed by December 31st each year.

Q: What is Rule 144?

A: An SEC rule that sets the conditions under which restricted, unregistered, and control securities can be sold or resold to the public.