Unit 8 - The Securities Exchange Act of 1934 and the Secondary Market Quiz/Test Questions

Your broker-dealer executes trades for other broker-dealers and after execution settles those transactions for them. Your firm would be classified as which of the following? A) Carrying firm B) Limited broker-dealer C) Fully disclosed firm D) Introducing firm

A) Carrying firm Explanation Carrying firms, or clearing broker-dealers, can execute trades, clear and settle transactions, take custody of customer funds and securities, and handle all back-office tasks, such as sending trade confirmations and statements for themselves as well as for other broker-dealers.

Which of the following is not part of the secondary markets? A) Mutual fund market B) Over-the-counter market C) Third market D) The exchanges

A) Mutual fund market Explanation Mutual funds, as open-end investment companies, do not trade in the secondary markets.

Correspondent firms would be likely to have relationships with which of the following types of broker-dealers? A) Self-clearing B) Market maker C) Introducing D) Fully disclosed

A) Self-clearing Explanation A self-clearing (or carrying) firm holds funds and securities of the fully disclosed or introducing firm's customers and performs related functions, such as sending confirmations and statements for them. Those firms for whom the carrying firm performs these services are known as their correspondents.

A broker-dealer that accepts the risk of holding a particular security in its account to facilitate trading and provide liquidity in that security is best described as A) a market maker. B) a direct participation program. C) a clearing corporation. D) a holding company.

A) a market maker. Explanation Market makers can be individuals or broker-dealers with a line of business to stand ready to buy or sell securities (make markets) with the view of being profitable by buying low and selling high or selling high and buying low (short selling). Market making is risky. Firms that do this must demonstrate to Financial Industry Regulatory Authority (FINRA) that they can manage the operational and financial risk.

A broker-dealer that concentrated its business efforts on proprietary trading would most likely be functioning as A) a market maker. B) an underwriter. C) an investment adviser. D) an investment banker.

A) a market maker. Explanation When a broker-dealer buys and sells securities for its own account as the major portion of its business model (e.g., proprietary trading), it is functioning primarily as a market maker (i.e., making markets in those securities). Investment banking and underwriting both primarily involve assisting issuers with bringing new securities issues to public investors. Investment advisers sell advice, they do not trade securities.

When a firm engages in proprietary trading, buying into and selling out of its own inventory for profit, it is acting as A) a market maker. B) an agent. C) an investment banker. D) an underwriter.

A) a market maker. Explanation When a broker-dealer buys and sells securities into and out of its own account as for the purpose of making a profit it is engaged in proprietary trading and is acting as a market maker (making markets in those securities). Investment banking and underwriting both primarily involve assisting issuers with bringing new securities issues to public investors. Agents act on behalf of others in the marketplace, such as a broker-dealer buying or selling for one of its customers.

An institution or a person responsible for making all investment, management, and distribution decisions in an account maintained in the best interests of another who has been legally appointed to provide these services is best described as A) a trustee. B) an investment advisor. C) a prime broker. D) a market maker.

A) a trustee. Explanation A trustee is legally appointed to manage as a fiduciary assets in a trust.

A central, physical, marketplace where securities are traded through a designated market maker is A) an exchange. B) the pit. C) the third market. D) the OTC.

A) an exchange. Explanation This description most aligns with the exchange model where securities are traded in a central location through a designated market maker.

All of the following are associated with being a carrying firm except A) being a fully disclosed firm. B) accepting customer funds. C) accepting customer securities. D) being able to clear customer transactions.

A) being a fully disclosed firm. Explanation A carrying firm has the capability to do trade executions, clear and settle transactions, and take custody of customer funds and securities. A fully disclosed firm is one that introduces its customer business to another firm for the purpose of clearing and settling transactions.

All of the following are acceptable choices to function as a depository and intermediary for transactions between buyers and sellers of securities except A) credit unions. B) the Depository Trust Company (DTC). C) carrying firms. D) the National Securities Clearing Corporation (NSCC).

A) credit unions. Explanation Credit unions cannot serve as a depository or clearing facility for securities transactions.

It is expected that financial markets A) have transparent pricing for assets. B) be nonregulated to allow for free trade. C) have securities prices determined by a board of directors. D) be limited to stocks and bonds and not include derivatives like options.

A) have transparent pricing for assets. Explanation A number of different assets, such as equities (stocks), debt (bonds), currencies, and derivative products like options can be offered and traded in the financial markets. These markets are expected to have transparent pricing aligning with supply and demand and to adhere to basic rules and regulations.

A fully disclosed broker-dealer A) is one that introduces its business to a carrying firm to clear transactions. B) is like a clearing agent in that it can take custody of funds and securities. C) is also known as a full-service clearing agent able to process and clear transactions. D) clears all of its retail customer transactions and those of other broker-dealers.

A) is one that introduces its business to a carrying firm to clear transactions. Explanation A fully disclosed broker-dealer is also known as an introducing broker-dealer because it introduces its business to a carrying firm that can clear and process transactions for it. Unable to clear transactions themselves, they are not a clearing agent or carrying firm and therefore cannot take custody of funds and securities.

A corporation enlists the services of a transfer agent, who would be expected to handle all of the following functions except A) registering the corporation's securities with the state. B) canceling old certificates and issuing new ones. C) maintaining records of shareholder ownership. D) replacing lost or destroyed stock certificates.

A) registering the corporation's securities with the state. Explanation The transfer agent for a corporation is responsible for ensuring that its securities are issued in the correct owner's name; canceling old certificates and issuing new ones; maintaining records of ownership; and handling problems relating to lost, stolen, or destroyed certificates. It is the registrar—a separate entity—who is responsible for registering the corporation's securities with the state.

Both the individual and institutional investor are able to easily buy and sell securities to meet their objectives through A) secondary markets. B) primary markets. C) outdoor malls. D) biennial markets.

A) secondary markets. Explanation This is the primary purpose of the secondary markets.

Electronic market centers designed primarily for institutional investors describes A) the fourth market. B) the third market. C) the OTC market. D) the exchanges.

A) the fourth market. Explanation The market centers that operate through electronic communication networks are known as the fourth market. These centers were created to serve large institutional investors like mutual funds and pension plans. The fourth market reduces the transparency of trading activity by these organizations and allows them to trade more efficiently.

Great Plains Securities, an OTC market maker, holds inventory and provides liquidity for Modulux Homes, an NYSE listed company. This is an example of A) the third market. B) the fourth market. C) the force market. D) the primary market.

A) the third market. Explanation When an exchange-listed security trades in the OTC market, it is being traded in the third market. The fourth market is composed of electronic communication networks and is primarily used by institutional investors. Primary markets are for raising capital.

A business entity that performs the function of receiving and delivering payments and securities on behalf of both parties to a securities transaction is called a A) depository. B) clearing agency. C) transfer agent. D) broker-dealer.

B) clearing agency. Explanation This is the function of a clearing agency. Although there are some broker-dealers that do act as clearing agents, being a broker-dealer does not always include providing the services of a clearing agent. The broker-dealer would need to meet all of the requirements of being a clearing agent.

All of the following are true regarding the term market except A) it includes stock exchanges. B) it is unique to the U.S. securities industry. C) it is where buyers and sellers come together for the purpose of trading assets. D) it can be a physical place or an electronic venue.

B) it is unique to the U.S. securities industry. Explanation The term market is used to describe any physical place or electronic venue where buyers and sellers can come together for the purpose of trading assets. Markets can be found in nearly every nation in the world and would include stock markets and other trading venues where they exist.

A broker-dealer designated as a clearing firm would be expected to do all of the following except A) perform back-office functions such as sending trade confirmations to customers. B) maintain a lower net capital than noncarrying broker-dealers. C) take custody of customer funds and securities. D) clear transactions for customer accounts.

B) maintain a lower net capital than noncarrying broker-dealers. Explanation A firm carrying customer funds and securities assumes certain risks, and is therefore required to maintain levels of net capital higher than that of firms who do not accept custody of funds or securities (noncarrying firms).

A broker-dealer's business model allows for only the purchase and sale of securities for retail customer accounts. It does not execute, settle, or clear its customer's transactions, nor does it tend to any back-office functions such as sending trade confirmations or forwarding proxies. This broker-dealer would best be described as what type of firm? A) Clearing agent/carrying agent B) Market making C) Introducing/fully disclosed D) Full service

C) Introducing/fully disclosed Explanation A fully disclosed introducing broker-dealer is what the word implies—it introduces its customer's business to a clearing firm. Clearing firms (often called carrying firms or agents) hold funds and securities and settle transactions (clear and process) for their correspondent introducing firms. Essentially, the clearing firm acts as the introducing firm's back office.

In a prime brokerage account, the prime broker A) subcontracts out all services to other brokers. B) provides custody and clearing, but no margin financing. C) provides custody and clearing services, as well as margin loans. D) provides execution services only, while another broker clears transactions and provides any other account services required.

C) provides custody and clearing services, as well as margin loans. Explanation In a prime brokerage account, the prime broker provides custody and clearing services (including margin loans). The prime broker may provide some execution services and contract with other brokers to provide additional execution services.

A firm designated as self-clearing can I act in a back-office capacity for an introducing firm. II not act in a back-office capacity for an introducing firm. III clear and settle transactions executed by other firms. IV only clear transactions it executed. A) II and IV B) II and III C) I and IV D) I and III

D) I and III Explanation Self-clearing firms not only clear and settle their own executions (transactions) but can clear the executions of other firms that would be considered introducing or fully disclosed firms. In this light, fully disclosed firms are those that introduce their business to clearing firms. Clearing and settling transactions includes providing any back-office functions needed.

Which of the following is true regarding a member firm operating under Financial Industry Regulatory Authority (FINRA) membership or the membership of another self-regulatory organization (SRO)? A) Member firms may never incorporate proprietary trading into their business model. B) Member firms are required to be full-service broker-dealers. C) Member firms must always accommodate dealing with retail investors and not limit business to that done with other industry professionals. D) Member firms can offer all types of investment products, such as stocks, bonds, mutual funds, options, and others or limit the products they offer to only a few. Explanation Member firms can offer all types of investment products such as stocks, bonds, mutual funds, and derivatives like options and others (be full service) or limit the products they offer to only a few. They need not adopt proprietary trading into their business model but can if they wish to. Likewise, they need not accommodate doing business with retail customers if they wish to deal only with other industry professionals, such as institutional investors.

D) Member firms can offer all types of investment products, such as stocks, bonds, mutual funds, options, and others or limit the products they offer to only a few. Explanation Member firms can offer all types of investment products such as stocks, bonds, mutual funds, and derivatives like options and others (be full service) or limit the products they offer to only a few. They need not adopt proprietary trading into their business model but can if they wish to. Likewise, they need not accommodate doing business with retail customers if they wish to deal only with other industry professionals, such as institutional investors.

A broker-dealer that executes trades and settles transactions for another broker-dealer is called A) an introducing firm. B) a fully disclosed firm. C) a limited broker-dealer. D) a carrying firm.

D) a carrying firm. Explanation Carrying firms, also known as clearing firms, execute trades, clear and settle transactions, take custody of customer funds and securities, and handle all back-office tasks such as sending trade confirmations and statements for themselves as well as for other broker-dealers classified as introducing or fully disclosed firms.

Secondary markets exist to do all of these except A) support the existence of primary markets. B) allow individual investors easy access to investment vehicles. C) allow investors to easily liquidate securities. D) decrease liquidity in the national markets.

D) decrease liquidity in the national markets. Explanation Secondary markets are focused on providing, not decreasing liquidity. Ultimately, a fair and orderly secondary market makes securities more attractive, supporting the functioning of the primary markets.

A firm that functions for the purpose of receiving and delivering payments and securities on behalf of both buyer and seller in a securities transaction is A) a broker-dealer. B) a transfer agent. C) a depository. D) a clearing agent.

A firm that functions for the purpose of receiving and delivering payments and securities on behalf of both buyer and seller in a securities transaction is Explanation A clearing agent is an intermediary between the buy and sell sides of a transaction that receives and delivers payments and securities on behalf of both parties. While some broker-dealers are self clearing (act as their own clearing agent), simply being a broker-dealer doesn't always include being able to provide the services of a clearing agent.

Which of the following statements would describe the Fourth Market? A) These transactions take place through electronic communications networks (ECNs). ECNs are open 24 hours a day and act solely as principals B) A market for institutional investors in which large blocks of stock, both listed and unlisted, trade in transactions unassisted by broker-dealers C) The after-hours market D) These transactions take place through electronic communications networks (ECNs) which are open during normal trading hours and act solely as principals

B) A market for institutional investors in which large blocks of stock, both listed and unlisted, trade in transactions unassisted by broker-dealers Explanation The Fourth Market is a market for institutional investors in which blocks of stock trade through ECNs that are open 24 hours a day acting as agents.

Which of these broker-dealers would most likely have correspondent firms? A) A market maker B) A self-clearing firm C) An introducing broker-dealer D) A fully disclosed broker-dealer

B) A self-clearing firm Explanation A self-clearing (or carrying) firm holds funds and securities of the fully-disclosed or introducing firm's customers and performs related functions, such as sending confirmations and statements for them. Those firms, for whom the carrying firm performs those services, are known as its correspondents.

A broker-dealer that accepts the risk of holding a particular security in its account to facilitate trading and provide liquidity in that security is best described as A) a clearing corporation. B) a market maker. C) a holding company. D) a direct participation program.

B) a market maker. Explanation Market makers can be individuals or broker-dealers with a line of business to stand ready to buy or sell securities (make markets) with the view of being profitable by buying low and selling high or selling high and buying low (short selling). Market making is risky. Firms that do this must demonstrate to Financial Industry Regulatory Authority (FINRA) that they can manage the operational and financial risk.

An institutional investor selects a single Financial Industry Regulatory Authority (FINRA)/NYSE member firm to provide for financing and custody of securities while orders to buy or sell are placed with executing brokers. This is an example of A) an omnibus clearing arrangement. B) a prime brokerage account. C) a managed account. D) an investment advisory account.

B) a prime brokerage account. Explanation A prime brokerage account is one in which a customer (an institution) selects one member to provide custody and financing of securities and executes trades with other firms known as executing brokers.

The transfer agent for a corporation is responsible for each of the following except A) ensuring that its securities are issued in the correct owner's name. B) acting as an intermediary between the buy and sell sides of a transaction. C) canceling old and issuing new certificates. D) maintaining records of ownership.

B) acting as an intermediary between the buy and sell sides of a transaction. Explanation The transfer agent (often a bank) for a corporation is responsible for ensuring that its securities are issued in the correct owner's name, canceling old and issuing new certificates, maintaining records of ownership, and handling problems relating to lost, stolen, or destroyed certificates. Acting as an intermediary in a trade is the function of the clearing corporation.

An institutional customer, such as a hedge fund, utilizes the services of a broker-dealer who provides custody of securities, as well as other back-office functions, while allowing the customer to establish relationships with other broker-dealers for the purpose of executing orders. This account would be known as a A) fully-disclosed account. B) prime account. C) clearing account. D) self-clearing account. Explanation A broker-dealer that provides custody of securities and other back-office functions but allows the customer to maintain relationships with other broker-dealers who will provide execution services is known as a prime broker-dealer. The account, known as a prime account, is maintained with the prime broker rather than with any executing brokers.

B) prime account. Explanation A broker-dealer that provides custody of securities and other back-office functions but allows the customer to maintain relationships with other broker-dealers who will provide execution services is known as a prime broker-dealer. The account, known as a prime account, is maintained with the prime broker rather than with any executing brokers.

A broker-dealer has a line of business restricted solely to the purchase and sale of securities with trade executions being handled by another member firm. Which of the following would best describe this type of firm? A) Market making B) Prime/executing C) Introducing/fully disclosed D) Clearing/carrying

C) Introducing/fully disclosed Explanation A fully disclosed introducing broker-dealer is what the word implies—it introduces its customers to a clearing firm. Clearing firms (often referred to as carrying firms) hold their customer's funds and securities as well as those of their correspondent introducing firms. Essentially, the clearing firm acts as the introducing firm's back office. Because the risk associated with holding customer funds and securities is not present, net capital requirements are much lower for introducing firms than they are for self-clearing or carrying broker-dealers.

An institution or a person responsible for making all investment, management, and distribution decisions in an account maintained in the best interests of another is known as A) a fully disclosed firm. B) a unit investment trust. C) a custodian. D) an investment company.

C) a custodian. Explanation A person responsible for making all investment, management, and distribution decisions in an account maintained in the best interests of another is known as a custodian, for example, the custodian for the account of a minor. This is different than a trustee who is a legally appointed entity. By contrast, anyone can open a custodial account for a minor as long as they are themselves an adult.

When a firm engages in proprietary trading, buying into and selling out of its own inventory for profit, it is acting as A) an agent. B) an investment banker. C) a market maker. D) an underwriter.

C) a market maker. Explanation When a broker-dealer buys and sells securities into and out of its own account as for the purpose of making a profit it is engaged in proprietary trading and is acting as a market maker (making markets in those securities). Investment banking and underwriting both primarily involve assisting issuers with bringing new securities issues to public investors. Agents act on behalf of others in the marketplace, such as a broker-dealer buying or selling for one of its customers.

An individual who purchases securities for a personal account is called A) an accredited investor. B) a market maker. C) a retail investor. D) an institutional investor.

C) a retail investor. Explanation An individual who makes investments such as the purchase of securities for his account rather than for an organization is a retail investor. This investor may be accredited, but there is no way to know for sure given the limited information.

The transfer agent for a corporation is responsible for each of the following except A) maintaining records of ownership. B) canceling old and issuing new certificates. C) acting as an intermediary between the buy and sell sides of a transaction. D) ensuring that its securities are issued in the correct owner's name.

C) acting as an intermediary between the buy and sell sides of a transaction. Explanation The transfer agent (often a bank) for a corporation is responsible for ensuring that its securities are issued in the correct owner's name, canceling old and issuing new certificates, maintaining records of ownership, and handling problems relating to lost, stolen, or destroyed certificates. Acting as an intermediary in a trade is the function of the clearing corporation.

Anyone who, as part of their business, gives investment advice for compensation must register as A) an agent for the issuer. B) a stock broker. C) an investment adviser under the Investment Advisers Act of 1940. D) an underwriter.

C) an investment adviser under the Investment Advisers Act of 1940. Explanation Broker-dealers who provide advice for a fee are subject to registration under this 1940 IA Act. Agents of investment advisers must register and pass a qualification examination.

A clearing corporation agent or depository for securities transactions A) must be a broker-dealer. B) can never be a corporation. C) can be a commercial bank. D) can be a bank or corporation only if they are also a broker-dealer.

C) can be a commercial bank. Explanation A clearing agent can be a broker-dealer but doesn't have to be. In addition to broker-dealers, commercial banks can act as clearing agencies and depositories, as can corporations that are set up specifically to clearing securities transactions and taking custody of funds and securities.

All of the following are acceptable choices to function as a depository and intermediary for transactions between buyers and sellers of securities except A) the National Securities Clearing Corporation (NSCC). B) the Depository Trust Company (DTC). C) credit unions. D) carrying firms.

C) credit unions. Explanation Credit unions cannot serve as a depository or clearing facility for securities transactions.

When investors buy and sell securities to and from one another, these transactions occur A) in the primary market. B) in the over-the-counter (OTC) market only. C) in the secondary market. D) on exchanges only.

C) in the secondary market. Explanation Primary market transactions involve the issuer or someone acting on behalf of the issuer, such as an underwriter. Secondary markets are where investors can buy and sell securities to and from one another. The secondary market includes exchanges and the OTC market.

Carrying firms may not A) execute transactions for their customers. B) send trade confirmations and statements to customers. C) clear and settle transactions for their customers. D) mix customer funds and securities with their own. Explanation Carrying firms can do trade executions, clear and settle transactions, and handle all back-office tasks, such as sending trade confirmations and statements. While they can take custody of customer funds and securities, they may not commingle them with those belonging to the firm. Abiding by the rule is known as segregating customer funds and securities.

D) mix customer funds and securities with their own. Explanation Carrying firms can do trade executions, clear and settle transactions, and handle all back-office tasks, such as sending trade confirmations and statements. While they can take custody of customer funds and securities, they may not commingle them with those belonging to the firm. Abiding by the rule is known as segregating customer funds and securities.

Secondary market transactions would include all of the following except A) sale of $10 million of municipal bonds by a broker-dealer acting as a market maker. B) sale of $10 million of U.S. Treasury bonds by a broker-dealer acting as a market maker. C) sale of $10 million of corporate stock by a broker-dealer acting as a market maker. D) sale of $10 million of corporate bond by a broker-dealer acting as an underwriter.

D) sale of $10 million of corporate bond by a broker-dealer acting as an underwriter. Explanation Market makers are broker-dealer who sell out of their own account in the secondary market. Underwriters are broker-dealers who help issuers bring their securities to market in the primary market.