Series 7 Unit 16

Immediate-or-Cancel (IOC)

IOC orders are like FOK except that a PARTIAL EXECUTION is ACCEPTABLE. The portion not executed is canceled.

Length of Limit Orders

Limit orders can be turned in with one or two different time restrictions. They can be good for the day entered (Day Order) or good 'til canceled (GTC), sometimes referred to as an open order.

Advantages of Margin accounts for Broker Dealers

Margin account loans generate interest income for the firm Margin customers typically trade larger positions b/c of increased trading capital, generating higher commissions for the firm.

Rules of the Securities Marketplaces

NYSE Euronext: The NYSE is the most widely known stock exchange. Although exchanges are call stock markets, other securities, such as bonds and or options may trade there as well. Often called the BIG BOARD, the NYSE is the largest of all US listed exchanges. Stocks listed on the NYSE can also be listed on regional exchanges, such as the Chicago Stock Exchange.

Stop-Limit Order

A stop-limit order is a stop order that once triggered, becomes a limit order instead of a market order.

Which of the following will NOT change the SMA balance in a long account? A. Sale of securities in the account B. Market appreciation of securities in the account C. Interest and cash dividends deposited in the account D. Decrease in value of securities in the account

Answer is D. E: The sale of securities in the account results in an automatic release of funds to SMA. Nonrequired cash deposits, such as interest and dividends, are also automatically credited to SMA. An increase in the value of the securities will increase SMA if the EE becomes greater than the existing SMA. ***A decrease in the market value of the securities will not increase or decrease SMA in a long margin account. It will, however, increase the SMA in a short margin account.

Volatile Market Conditions Rule 80B

Rules known as the market-wide circuit breaker rules protect against rapid, uncontrolled drops in the market. A market-wide trading halt will be triggered if the S&P 500 index declines in price by specified percentages from the prior day's closing price of that index. Those triggers are currently set at three circuit breaker thresholds as follows: Level 1 Halt = 7% decline in S&P 500 -before 3:25pm--15 minutes -at or after 3:25pm--trading may continue unless there is a level 3 halt Level 2 Halt = 13% decline in S&P 500 -before 3:25pm--15 minutes -at or after 3:25pm--trading may continue unless there is a level 3 halt Level 3 Halt = 20% decline in S&P 500 -at any time, trading will halt and not resume the rest of the day. A Level 1 or level 2 halt can't occur more than one time per day. If a level 1 has already occurred, it would take a level 2 halt to stop trading again. Finally, trading halts for listed securities trading on an exchange will generally be initiated by the exchange itself or the SEC. For OTC stocks, either FINRA or specific trading venues such as Nasdaq can initiate a trading halt. **During a market halt, while no trading can occur, investors can still cancel existing (open) orders that had been entered previously. **

Using SMA

SMA is a line of credit; therefore, the investor can use it to withdraw cash or meet the margin requirement on stock purchases. The customer can use SMA for a loan as long as doing so doesn't cause a maintenance call. Using SMA for a loan increases debit balance by the equal amount and reduces equity by the same amount. SMA can also be used to meet initial margin requirements on stock purchases. SMA gives the investor buying power. ***Example: If using $20,000 of SMA to purchase stock, for every $1 of SMA, the customer can purchase $2 of stock. The SMA goes to 0. The LMV goes up $40,000, the DR goes up $40,000 and the EQ stays the same. The REG T and minimum maintenance are adjusted accordingly.

Insider Short Sale Regulations

The Securities Exchange Act of 1934 prohibits directors, officers, and principal stockholders (insiders) from selling short stock in their own companies.

Arbitrage

Trading to get profit from the temporary price disparities in the same or equivalent securities during the day. This is perfectly legal.

Interpositioning

When acting in an agency capacity for a customer, a member firm can't place a 3rd party between itself and the best available market (members can't route an order through another firm). They must go directly to the best available market (to a firm at the inside market). That is the practice of interpositioning. Generally, interpositioning results in a less-favorable price to the customer, as the 3rd party will trade at the inside market and then add additional costs for itself. **The only time interpositioning can be justified is if it results in a better execution for the customer. Better means a lower price than the inside offer or a higher price than the inside-bid.**

Analyzing Short Margin Account Activity

When establishing a short margin account, there is a minimum deposit of $2,000. This minimum must be met EVEN if the customer sells short less than $2,000 worth of securities. The REG T requirement for short sales is the same as it is for long purchases: 50%

Priority, Precedence, and Parity

When more than one broker enters the same bid or offer, the specialist (DMM) awards the trade in the following order: 1. Priority--first order in 2. Precedence--largest order of those submitted 3. Parity--spin the parity wheel(random)

Not all exchanges accept each type of order

**

List of Important Test Points about OTC Quotes

-markups and markdowns are charged when a market maker is acting as a principal (dealing from inventory with financial risk) -unless stated otherwise, firm quotes are good for a round lot only. -nominal quotes can be given for informational purposes and can be printed only if clearly labeled as such -a relatively wide spread indicates a thin trading market for the security -securities identified as OTC non=Nasdaq may not always have last sale info readily available. That is b/c that info may be difficult to find for these thinly traded securities.

Spread Factors

-the issue's size -the issuer's financial condition -the amount of market activity in the issue -the market conditions ***TTA*** a phrase worth remembering is "The more active a security, the more narrow the spread" the reverse is true

Buy Stop Order

A buy stop order protects a profit or limits a loss in a short stock position. The buy stop is entered at a price above the current market and is triggered when the market price touches or goes through the buy stop price. Buy stop orders are also used by technical traders who track support and resistance levels for stocks. For instance, on collect on delivery (COD) stock trades between 38 and 42. It never seems to go above 42 or below 38. Technicians believe that if the stock breaks through resistance, it will continue to move upward at a rapid pace. Therefore, they will not buy at 40 because there is little upside potential. However, they may place a buy stop order above the resistance level, knowing that if the stock breaks resistance and begins moving up, they will buy the stock before it develops upward momentum. An investor might place a stop order to buy 100 COD at 42.25 stop when the market is at 40 if she believes 42 represents a technical resistance point, above which the stock price will continue to rise.

Combined Margin Accounts

A client who has a margin account with both long and short positions in different securities has a combined account. In combined accounts, equity and margin requirements are determined by calculating the long and short positions separately and combining the results. Calculating the combined equity: LMV + CR - DR - SMV = Equity

Risks of Limit Orders

A customer who enters a limit order risks missing the chance to buy or sell, especially if the market moves away from the limit price. Sometimes limit orders are not executed even if the stock trades at the limit price. Why would that happen? A term you should be aware of is stock ahead. Limit orders on the DMM's book for the same price are arranged according to when they were received. If a limit order at a specific price was not filled, chances are another order at the same price took precedence--that is, there was a STOCK AHEAD. Limit orders stand in time priority. There may be multiple orders to buy a stock at a particular price. Once the stock begins trading at that price, those limit orders that were entered first will be filled first.

Pattern Day Traders

A day trader is someone who buys and sells the same security on the same day to try and take advantage of intraday price movements. A pattern day trader is someone who executes four or more trades in a five-business-day period. Pattern day traders are also treated differently when it comes to buying power. Buying power for day traders is four times the maintenance margin excess. MAINTENANCE MARGIN EXCESS is defined as the equity in the account above the 25% minimum requirement. For regular customers, buying power is 2 times SMA. Margin rules also prohibit day trading accounts from using account guarantees, which are otherwise permitted. A cross guarantee is one for which another customer, in writing, agrees to the use of money or securities in her account to carry the guaranteed accounts.

Do Not Reduce (DNR)

A do not reduce order is not reduced by an ordinary cash dividend. In this case the customer does not care if there is an execution due solely to the ex-date reduction. TTA** You are likely to be asked which orders are reduced for cash dividends. Only those placed below the market price are automatically reduced. Remember that BLiSS orders are placed below the market price and are reduced for cash dividend distributions. All orders are adjusted for stock dividends and stock splits, whether placed above or below the market.

Backing Away

A market maker can revise a firm quote in response to market conditions and trading activity, but a market maker who refuses to do business at the price(s) quoted is backing away from the quote. Backing away is a violation of trading rules. If you see this on the exam, remember, it is a ad thing to back away from a firm quote.

Not Held (NH) Orders

A market order coded NH indicates that the customer agrees not to hold the floor broker or BD to a particular time or price of execution. This provides the floor broker with the authority to decide the best time or price at which to execute the trade. Market NH orders MAY NOT be placed with the NYSE DMM. *Take Note* Under FINRA Rule 3260, market NH orders in which a retail customer gives you authority over price or timing, are limited to the day the order is given. They are day orders.*

Nominal Quote

A nominal quote is someone's assessment of where a security might trade in an active market. Nominal quotes may be used to give customers an idea of the market value of an inactively traded security, but they are not firm quotes. Nominal quotes in print must be clearly labeled as such. These are common with municipal bonds b/c the market for so many of them is very thin.

Qualified Quotes

A quote will often be given with qualifiers intended to allow the dealer to back away if market conditions change.

Sell Stop order

A sell stop order protects profit or limits a loss in a long stock position and is entered at a price below the current market. Technical traders use sell stop orders. They beleive that if a stock breaks through support it will fall like a rock. They may place a sells top order just below the support level, knowing that if the stock breaks through support and begins to move down, they will short the stock before it develops downward momentum. An investor who is long stock might place a stop order to sell 100 COD at 37.75 stop when the market is at 40 if he believes 38 represents a technical support point below which the stock will continue to fall. If a large number of stop orders are triggered at the same price, a flurry of trading activity takes place as they become market orders. This activity will accelerate the advance or decline of the stock price.

Short Sale Rules

A short sale involves the sale of a security that the customer does not own. To make delivery, the BD lends the security to its customer. After settlement of the trade, the BD credits the proceeds to the customer's account. Short selling is the buy low-sell high principle, but in reverse, where the sale is made before the purchase. The short seller profits if the stock declines in value but has a potentially unlimited loss if the stock appreciates. **All short sales must be done in a short margin account, and the BD must make sure the customer who sells short understands the risks and that opening the account is suitable. Short sales may occur anytime during the trading day, including at the opening and closing of the day. The only requirement is that the BD has or is able to locate the shares to lend.

Stop Orders

A stop order, aka a stop loss order, is designed to protect a profit or prevent a loss if the stock begins to move in the wrong direction. The stop limit order becomes a market order once the stock trades at or moves through a certain price, known as the stop price. Stop orders are left with and executed by the DMM. There is no guarantee the executed price will be the stop price, unlike the price on a limit order. Buy stop orders are entered above the current market, whereas sell stop orders are entered below the current market. A trade at the stop price triggers the order, which then becomes a market order. A stop order takes 2 trades to execute, which are: -Trigger: the trigger transaction at or through the stop price activates the trade. -Execution: The stop order becomes a market order and is executed at the next price, completing the trade.

All-or-None (AON) Orders

AON orders must be executed in their entirety or not at all. AON orders can be day or GTC orders. They differ from FOK in that they do not have to be filled immediately.

In an initial transaction in a margin account, a customer sells short 200 ABC at $18 per share and makes the initial required deposit. The credit balance in the account is A) $5,600. B) $2,400. C) $5,400. D) $2,000. The minimum equity requirement for short accounts is $2,000. The investor receives $3,600 from the proceeds of the sale and must deposit $2,000; therefore, the credit balance is $5,600 ($3,600 + $2,000 = $5,600).

Answer is A E:The minimum equity requirement for short accounts is $2,000. The investor receives $3,600 from the proceeds of the sale and must deposit $2,000; therefore, the credit balance is $5,600 ($3,600 + $2,000 = $5,600).

Which of the following statements regarding SMA balances is true? A) SMA balances may be withdrawn provided the withdrawal does not bring the account below minimum maintenance. B) SMA balances may be withdrawn without restriction regardless of the account status being below or brought below minimum maintenance by the withdrawal. C) SMA balances are free credit balances available to be withdrawn upon demand. D) SMA balances, which are considered a line of credit, may only be used to purchase additional securities.

Answer is A Explanation: SMA is a line of credit that may always be withdrawn (even in a restricted account), provided the withdrawal does not bring the account below minimum maintenance.

A customer has the following margin account balance: Market value: $50,000 Balance: (DR) $26,000 SMA: $0 Regulation T: 50% If a customer sells securities in the amount of $20,000 in this account, what is the maximum amount she can withdraw from the account after the settlement date? A) $10,000 B) $6,000 C) $14,000 D) $10,500

Answer is A When stock is sold in a restricted margin account, 50% of the proceeds can be withdrawn. This account is restricted because the equity of $24,000 (LMV of $50,000 − DR of $26,000) is less than Regulation T ($25,000 = 50% of the LMV) but more than minimum maintenance ($12,500 = 25% of the LMV).

An investor has a short margin account. The current market value of the stock is $1.50 per share, and the investor owns 1,000 shares. Compliance with SRO minimum maintenance requirements is met with account equity of A) $2,000. B) $2,500. C) $1,500. D) $1,950.

Answer is B E: For stock trading under $5 per share, a customer must maintain 100% of SMV or $2.50 per share, whichever is greater. $2,500 (1,000 shares @$2.50) is greater than 100% of $1,500.

XYZ Corporation has set Friday, January 23, as the record date for its next quarterly dividend distribution. To receive the dividend, a customer, long 1 XYZ Feb 40 call, must issue exercise instructions on or before A) Tuesday, January 20. B) Friday, January 23. C) Wednesday, January 21. D) Monday, January 19.

Answer is C E: Dividends are paid to investors who are owners of record as of the close of business on the record date. When a call option is exercised, money and stock are exchanged (settlement) on the second business day after notice is given to the Options Clearing Corporation. Therefore, an investor who wishes to receive a dividend must exercise a call no later than the second business day before the record date (i.e., the day before the ex-date). This is no different from anyone else purchasing stock before the ex-date.

Which of the following actions would increase SMA in a long margin account? A) A long purchase B) A decline in CMV C) A long sale D) A stock dividend received

Answer is C E: Of these choices, an increase in SMA can only be accomplished by a sale of securities held long in the account. A purchase would decrease the SMA if it is used to make the purchase. Stock dividends have no effect on the balances in a long margin account; only the number of shares is changed. A decline in the CMV would not change the SMA.

In a new margin account, a customer buys 300 shares of ABC at $40 per share, 100 shares of the Ajax Mutual Fund at $24, and 10 PDQ Aug 30 calls at 4. The customer will receive a margin call for A) $10,800. B) $4,400. C) $12,400. D) $9,200.

Answer is C E: The customer must pay 50% of the value of the stock and 100% of the value of the mutual fund shares and the options because these securities are nonmarginable and require full payment. To calculate the total payment required, add $6,000 (50% of $12,000) plus $2,400 (Ajax) plus $4,000 (PDQ calls) to arrive at $12,400.

The locate requirement of Regulation SHO for short sales does not apply to A) preferred stock traded on the NYSE. B) over-the-counter equity securities. C) nonconvertible bonds traded on the NYSE. D) American depositary receipts traded on the Nasdaq Stock Market.

Answer is C E: The locate requirement is applicable to all short sales of equity securities. It is unlikely to be tested, but, just in case, for purposes of this rule, convertible bonds are considered equity securities.

A customer's margin account shows a debit balance of $10,000. Federal law permits the broker-dealer to rehypothecate a maximum of A) $10,000 of the customer's margin securities. B) $5,000 of the customer's margin securities. C) $20,000 of the customer's margin securities. D) $14,000 of the customer's margin securities.

Answer is D E: When a customer buys securities on margin, the broker-dealer holds the purchased securities as collateral for the margin loan. That is known as hypothecation. In most cases, broker-dealers rehypothecate the securities to a lending institution to recover the funds they loaned to the margin client. SEC rules limit the rehypothecation to 140% of the customer's debit balance (140% × $10,000 = $14,000).

EE and SMA continued...

Any of the following also generates SMA: -Nonrequired cash deposits: if a customer deposits cash that is not required to meet a margin call, the full amount reduces the debit and is also credited to SMA. -Dividends: dividends received on securities in the margin account are added to SMA. The customer can withdraw these income distributions, even if the account is restricted. -Loan Value: If a customer makes a nonrequired deposit of marginable stock, the stock's loan value is credited to SMA. B/c the loan value is 50% of the current market value, the credit is equal to half what would be gained by a deposit of an equal cash amount. -Sale of Stock: when stock is sold, 50% of the sales proceeds is credited to SMA. Take Note: customers wishing to remove cash dividends coming into their margin accounts must do so within 30 days of receipt. Otherwise, the cash dividend is applied against the debit balance, thereby increasing the equity in the account.

Convertible Security Arbitrage

Arbitrage trades are also possible in equivalent securities--convertible bonds and the underlying stock, for instance. If conditions are right, an arbitrageur may be able to convert bonds to stock and sell the stock for a profit.

Customer Portfolio Margining (CPM)

As with some other points we've made throughout the course, this topic is in FINRA's content outline but we have not run across it in the exam. Customer Portfolio Margining (CPM) is a different way to calculate margin requirements for an account based on the net risk of an entire portfolio of securities rather than a standardized percentage applied to each individual position. Margin requirements calculated this way are generally lower than those that are calculated conventionally. BDs must meet certain requirements if they wish to offer portfolio margining to customers. Among those are the following: -The customer must be approved to engage in uncovered short option transactions. -Depending on the firm's capabilities, customer accounts must have a minimum equity of $100,000 or even more. -REITs, even those listed on the NYSE, can be included

Alternative Orders (OCO)

Assume a customer is long stock at $50 that was purchased 6 months ago at $30. To protect their unrealized gain, the customer might enter a sell stop at $48. Alternatively, if the stock continues to rise, he wants out at $53. What he might do is enter both orders with the notion, ONE CANCELS THE OTHER (OCO). If one order is executed, the other is immediately canceled.

Risk Disclosure

Before or at the time of opening a margin account, a member firm must provide customers with a margin disclosure statement. The document discusses the risks associated with the margin trading, some of which follow: -Customers can lose more money that initially deposited -Customers are not entitled to choose which securities or other assets in their account are liquidated or sold to meet a call for additional funds -Customers are not entitled to an extension of time to meet a margin call -Firms can increase their in-house margin requirements without advance notice. - - -

Why use stop orders?

Buy Stop Orders: -protect against loss in a short stock position -protect a gain from a short stock position -establish a long position when a breakout occurs above the line of resistance Sell Stop Orders: -protect against loss in a long stock position -protect a gain from a long stock position -establish a short position when a breakout occurs below the line of support

Reducing Orders

Certain orders on the DMM's order book are reduced when a stock goes ex-dividend. All orders entered below the market are reduced on the ex-dividend date (or ex-date)--the first date on which the new owner (purchaser) of stock does NOT qualify for the current dividend. On the ex-date, the stock price opens lower by the amount of the distribution. Orders reduced include buy limits and sell stops, including sell stop-limit orders. These orders are reduced by the dividend amount. W/out this reduction, trading at the lower price on the ex-dividend date could cause inadvertent execution.

Exempt Securities

Certain securities are exempt from Regulation T margin requirements. When purchased in a margin account, they are subject to the firm's determination of an initial requirement. Firms must follow maintenance requirements established by FINRA or their SRO rules. Other than knowing which securities are exempt, it is unlikely you will be asked anything else about them. Securities exempt from Regulation T include: -US treasury bills, notes, and bonds -government agency issues -municipal securities

Initial Requirements

Customers are required to deposit a minimum amount of equity for their FIRST PURCHASE in a margin account. Although Regulation T states that a deposit of 50% of the market value of the purchase is required, FINRA rules require that this initial deposit cannot be less than $2,000.00 unless paid in full. The customer must deposit the greater of the Regulation T requirement or the FINRA minimum. The exception occurs when the customer's initial purchase is less than $2,000. There is another way to look at this: if the customer's first purchase in a margin account is less than $2000, deposit 100% of the purchase price.

Margin Account Areeements

Customers who open margin accounts must sign a MARGIN AGREEMENT before trading can begin. The agreement consists of 3 parts: -the credit agreement -the hypothecation agreement -the loan consent form

Designated Market Maker (DMM)

DMMs facilitate trading in specific stocks, and their chief function is to maintain a fair and orderly market in those stocks. In fulfilling this function, they act as both brokers and dealers. They act as dealers when they execute trades for their own accounts and as brokers when they execute orders other members leave with them. The specialist (DMM) acts as an auctioneer. In return for providing this service to the exchange, DMMs receive rebates on fees charged by the exchange whenver their quotes result in trades.

Excess Equity and the SMA

Excess Equity (EE) in a margin account is the amount of equity exceeding the REG T requirement. Its the amount of Equity higher than the REG T requirement, usually happens when the LMV increases. DR doesn't change when the market value of the securities changes. But the EQ changes up when the LMV goes up since the EQ is the difference between the LMV - DR. **A rule to determine SMA is as follows: for every $1 increase in market value, $0.50 of SMA is created. EE creates SMA, or BUYING POWER, in the account. SMA is a line of credit that a customer can borrow from or use to purchase securities. When the SMA line of credit is used, the debit balance in the customer's account is increased and the equity falls. ***SMA does NOT decrease if there is a decrease of market value. SMA may be more than EE and may exist even if there is no EE in the account*** SMA is equal to the greater of the amount of existing SMA or the value of EE.

Auction Market

Exchange securities are bought and sold in an auction market. Exchange markets are also sometimes called double-auction markets b/c both the buyers and sellers call out their best bids and offers in an attempt to transact business as the best possible price. To establish the best bid, a buying BD must initiate a bid at least $0.01 higher than the current best bid. The best offer by a selling BD must be at least $0.01 lower than the current best offer.

Minimum Maintenance (Short margin account)

FINRA minimum maintenance requirements rules on short positions are 30%, compared with 25% on long positions. As with long margin accounts, the firm may impose a higher house minimum. Minimum initial dollar requirement? $2000 RET T requirement? 50% Minimum Maintenance requirement? 30%

**TTA**

Failure to maintain or adequately staff an OTC order room or other department assigned to execute customer's orders can't be considered justification for executing away from the best available market. Channeling orders through a 3rd part, as reciprocation for service or business generated, can't operate to relieve a member of its obligation s under this rule.

Types of Quotes

Firm Quote Subject Quote Qualified Quotes The OTC market is a negotiated market. BDs are trading with other BDs, and there are different types of quotes. (above)

Margin Accounting

For active margin accounts, BDs must verify that equity in the account still meets minimum requirements following fluctuations in market value. The practice of recalculation to check the status of the equity in the account is called marking to the market. It is typically done every business day on the basis of the closing price of the stock. This concept applies to both long and short margin accounts, which will be discussed separately.

Good Til Canceled (GTC) Orders

GTC orders are valid until executed or canceled. However, all GTC orders are automatically canceled if unexecuted on the last business day of April and last business day of October. If the customer wishes for the order to remain working passed those days, the customer must REENTER the order.

TTA***

Here is a quick review of critical loan margin account concepts: -The first transaction in a margin account requires a deposit of the greater of 50% of the LMV or $2,000. The $2,000 minimum is waived if 100% of the transaction is less than $2,000 -The basic margin equation is : LMV - DR = EQ -REG T = 50% of LMV -Minimum Maintenance = 25% of the LMV -SMA can be borrowed from the account, dollar for dollar -Utilizing SMA increases the debit balance. -The buying power of SMA is 2:1 -EE and SMA are not necessarily equal. -SMA cannot be used to meet a maintenance margin call -The market value at maintenance equation for loan margin accounts is DR / 0.75 or DR x 4/3. This calculates what the market value can fall to before a maintenance call is sent. -Exempt securities are not subject to REG T but are subject to the maintenance requirements of FINRA.

Restricted Account Rules

If an account is restricted, the following rules apply: -to purchase additional securities, put up 50% -to withdraw securities from the account, the customer must deposit cash equal to 50% of the value of the securities to be withdrawn -if securities are sold in a restricted account, at least half the proceeds must be retained in the account to reduce the debit balance. This is called the RETENTION REQUIREMENT. Also, 50% of the proceeds are credited to the SMA. **SMA is used like a line of credit with a bank. SMA preserves the customer's right to use excess equity. ** ****Equity is only affected if the customer elects to remove a portion of the proceeds****

Loan Consent Form

If signed, the loan consent form gives permission to the firm to lend out customer margin securities to other customers or BDs, usually for short sales. **It is mandatory that the customer sign the credit agreement and hypothecation agreement. The loan consent form is OPTIONAL.** The interest paid by margin customers on money borrowed is a variable rate based on the broker call rate.

Restricted Accounts

If the equity in the account is less than the REG T requirement but greater than or equal to the minimum maintenance requirement, the account is RESTRICTED. If an account becomes restricted, there is no requirement for the customer to take any action to remove the account from the restricted status. A maintenance call will be sent only if the account falls below the minimum maintenance requirement.

Reductions for Stock Splits

If there is a stock dividend or stock split, the DMM will adjust all open orders. Examples: an open GTC order to sell 100 ABC at 50 stop. If there is a 2:1 split, the order becomes sell 200 ABC at 25 an open order to buy 500 ABC at 30. If there is a 20% stock dividend, the order becomes buy 600 ABC at 25 an open order to buy 100 ABC at 30. There is a 20% stock dividend, the order becomes buy 100 ABC at 25. ***Common sense says the order size should be 120 shares. HOWEVER, only round lots are allowed on the order book. The additional 20 shares are in the customer's account but cannot be part of an open order.*** **For reverse splits, ALL open orders are canceled.***

Best Execution of Customer Orders

In any transaction for or with a customer, a member must use reasonable diligence to find the best market for the subject security. Once completed, the trade should be executed so that the resultant price to the customer is as favorable as possible under prevailing market conditions. FINRA RULE 5310 considers the following factors in determining whether a member has used "reasonable diligence": -the character of the market for the security -the size and type of transaction -the number of markets checked -accessibility of the quotation -the terms and conditions of the order that result in the transaction, as communicated to the member and persons associated with the member

Borrowing Securities

Investors cannot sell short if they are not able to borrow the security they are selling. Securities can be borrowed from -the member firm executing the short sale on behalf of the customer -margin customers of that member firm -other member firms -institutional investors, such as pension plans and custodial banks. When opening a margin account, customers often sign a loan consent agreement that allows custodians to lend customer margin securities from the portfolio. Certain sophisticated investors and institutional customers, such as pension funds, lend securities to generate additional income in their portfolios by charging for the loan.

Mark to Market

Mark to market, sometimes called marking to the market, is simply making daily adjustments to the customer's margin account as the price of the underlying security changes. In a short position where the stock's price increases, the equity in the account goes down. Of course, when the price of the short security drops, the effect on the account's equity is positive.

Marginable Securities Continued...

May be purchased on margin and used as collateral: -Exchange-listed stocks, bonds -Nasdaq stocks -non-Nasdaq OTC issues approved by the Federal Reserve Board -warrants CANNOT be purchased on margin and CANNOT be used as collateral: -Put and call options -Rights -non-Nasdaq OTC issues NOT approved by the Federal Reserve Board -insurance contrats CANNOT be bough on margin, but CAN be used as collateral after 30 days: -Mutual Funds -new issues

Approval for Day Trading Accoutns

Member firms who promote day trading strategies must now implement procedures to approve day trading accounts. Before opening an account, the member must: -provide the customer with a risk disclosure statement that outlines all the risks associated with day trading -approve the account for a day trading strategy or receive fro mthe customer a written statement that the customer does not intend to engage in day trading

Time Sensitive Orders

Orders based on time considerations include: -Day -Good until canceled -At-the-open or market-on-close -Not held -Fill-or-kill -Immediate-or-cancel -All-or-none -Alternative, which provides two alternatives, such as sell a stock at a limit or sell it on stop

Bids, Offers, and Quotes

Quotations are available for both listed and unlisted securities. In the case of stocks traded on the NYSE, the quotes come from the DMM. These are available electronically, even to retail investors. In the case of the OTC market, the quotations originate with the market makers. Exam questions are more likely to focus on them than on the DMM, at least when it comes to understanding the types of quotes. The OTC market has no DMMs. Instead, firms wishing to make a market in a particular security must register with, and receive approval from FINRA. They buy and sell for their own inventories, for their own profit, and at their own risk. A BD acting as a market maker, buying and selling for his own account rather than arranging trades, acts as a principal, not as an agent. (also known as proprietary trading) A full quote consists of a bid price and an offer (ask) price. When coming from the market maker, it will also include the size. The current bid is the highest price at which the market maker will pay to buy, and the current offer is the lowest price at which the market maker will accept to sell. The difference between the bid and the ask is called the spread.

Short Sales

Receives premium with the obligation to sell the security at the strike price. Hopes the price of the security goes down. B/c short selling involves borrowing, all short sales must be done in a margin account.

Marginable Securities

Regulation T also identifies which securities are eligible for purchase on margin and which may be used as collateral for loans for other purchases. Margin: is the amount of equity that must be deposited to buy securities in a margin account. Marginable: refers to securities that can be purchased on margin and can be used as collateral in a margin account.

Long Margin Account affect SMA

Rise in market value increases SMA. SMA increases only if the new EE is higher than the old SMA. Sale of securities increases SMA. The client is entitled to EE in the account after the sale, or up to 50% of the sales proceeds, whichever is greater. Deposit of cash increases SMA. The full amount of the deposit is credited to SMA. Deposit of marginable securities increases SMA. SMA is increased by the loan value of the securities deposited, as prescribed by REG T at the time of deposit (50%) Dividends or interest received increase SMA. 100% of a cash dividend or interest is credited to SMA. Purchase of securities decreases SMA. The margin requirement on new purchases is deducted from SMA. If SMA is insufficient to meet the charge, a REG T call is issued for the balance. Withdrawal of cash decreases SMA. The full amount of the cash withdrawal is deducted from SMA. Remaining equity may not fall below FINRA rules or house equity requirement. Fall in long account market value has no effect on SMA. After the SMA balance is established, it is not affected by the fall in market value in a long account. Interest charges to account has no effect on SMA. Stock dividend or split has no effect on SMA.

Short Margin Account Math

SMV + EQ = CR The amount the market value of securities falls is the amount that the equity will rise. Short positions, like long positions, are marked to market daily to reflect any change in position value. Status of the account? -Excess Equity: Equity in excess of REG T -Restricted: equity less than REG T, and greater than or equal to minimum maintenance -Maintenance Call: equity less than the minimum maintenance of 30% SMV EE and SMA are calculated the same. To find the maximum market value to which a short sale position can increase before a maintenance call is issued, apply the following formula: total credit balance / 1.3 (This is known as the SMV at maintenance)

Exchange Listing Requirements

Securities traded on the NYSE, known as LISTED SECURITIES, must satisfy the exchange's listing requirements. Generally, a corporation that wants its securities listed must have a minimum number of publicly held shares and a minimum number of shareholders, each holding 100 shares or more. Although the minimum numerical criteria are not tested, it is important that you recognize that only companies of significant size and public ownership qualify for listing in the NYSE. Only NYSE members can trade on the floor. The NYSE is not the only exchange; regional exchanges tend to focus on the securities of companies within their regions, although they also offer trading in many securities listed on the NYSE. This is known as DUAL LISTING. Listing requirements on regional exchanges are often less stringent than those of the national exchanges, and the companies they list are usually among the smallest and newest in their industries.

Short Sales and Margin Requirements

Short sales are always done in a short margin account. In a short sale, there is a SHORT SELLER, a STOCK LENDER, and a BUYER who purchases the shares being sold short. One of the basis requirements of short selling is that the short seller, on the dividend payment date, must make good to the stock lender for the dividends the lender is no longer receiving from the issuer. The buyer of the shares is receiving the dividends directly from the issuer. Therefore, on the dividend payment date, the short seller's account is debited the amount of the cash dividend for remittance to the stock lender.

Price-Restricted Orders

Some orders, such as limit and stop-limit, restrict the price of the transacton. Typical orders include the following: -Market: Executed immediately at the market price -Limit: limits the amont paid or received for securities -Stop: becomes a market order if the stock reaches or goes through the stop (trigger or election) price -Stop-Limit: Entered as a stop order and changed to a limit order if the stock hits or goes through the stop (trigger or election) price

Market Arbitrage

Some securities trade in more than one market--on 2 exchanges, for instance--creating the possibility that one security may sell for two different prices at the same time. When that happens, arbitrageurs buy at the lower price in one market and sell simultaneously at the higher price in the other. Arbitrage is NOT a type of market manipulation.

Shorting Bonds

Some securities, such as listed stocks, have many equivalent securities trading at any time. For instance, it is easy to short 100 shares of an NYSE listed stock B/c an equivalent 100 shares of taht stock can be purchased on the NYSE at any time. It is not easy to cover shorts for most muni bonds b/c the limited number of bonds available in each issue could make it difficult to buy back the short position. The muni market is too thin. SHORT SELLING MUNI BONDS IS ALMOST NEVER DONE

Sell Order Tickets

The SEC requires that all sell orders be identified as either long or short. No sale can be marked long unless the security to be delivered is in the customer's account or is owned by the customer and will be delivered to the broker by the settlement date. A person is long a security if they: -has title to it -has purchased the security or has entered into an unconditional contract to purchase the security but has not yet received it -owns a security convertible into or exchangeable for the security and has tendered such security for conversion or exchange -has an option to purchase the security and has exercised that option *unless one or more of these conditions are met, the SEC considers any sale of securities a short sale*

Regulation T

The Securities Exchange Act of 1934 gives the Federal Reserve Board the authority to regulate the extension of credit in the securities industry. For margin accounts, Regulation T states that customers must deposit a minimum of 50% of the transaction within 2 additional business days of regular way settlement (T+2 for most securities). This is sometimes expressed as S+2, (settlement plus 2). Therefore, the deposit must be done within 4 business days of the transaction. Take note** Regulation T time limit applies to both cash and margin accounts. Customers have 2 business days after settlement to make their required payment, regardless of the account type. BDs expect their customers will pay on the settlement date. The industry views the Regulation T rule as a 2 day cushion.

Credit Agreement

The credit agreement discloses the terms of the credit extended by the BD, including the method of interest computation and situations under which interest rates may change.

Workout Quote

The term WORKOUT QUOTE is usually reserved for situations where a market maker knows that special handling will be required to accommodate a particular trade. Either the order size is too big for the market to absorb without disruption or the market is too thin or temporarily unstable. A workout quote is an approximate figure used to provide the buyer or the seller with an indication of price, not a firm quote.

Types of Margin Accounts

There are 2 types of margin accounts: Long and Short Long margin account--customers purchase securities and pay interest on the money borrowed until the loan is repaid. Short margin account--stock is borrowed and then sold short, enabling the customer to profit if its value declines. All short sales must be executed through and accounted for in a margin account. *In long margin accounts, customers borrow money; in short margin accounts, customers borrow securities. Advantages of Margin accounts for customers are that they can: -purchase more securities with a lower initial cash outlay -LEVERAGE the investment by borrowing a portion of the purchase price leveraging magnifies the rate of return but also magnifies the rate of loss.

Fill-or-Kill (FOK) Orders

The commission house broker is instructed to fill an ENTIRE FOK order immediately at the limit price or better. A broker who cannot fill the entire order immediately cancels it and notifies the originating branch office.

Orders involving Securities with Limited Quotations or Pricing Information

This is not an issue for stocks traded on the NYSE or the Nasdaq or the Nasdaq Stock Market. BUT for stocks traded on the OTC Link, the pricing information is frequently quite limited. In addition, the specified security's quotes or trades might not be shown for weeks at a time. Furthermore, when there is a quote, it is often from a single market maker. Without competition, it is just like a store selling something that no one else has--it can set the price wherever it wants. In these instances, a member should generally seek out other sources of pricing information or potential liquidity, which may include obtaining quotations from other sources.

Subject Quote

This is the opposite of a firm quote. A subject quote requires further confirmation. It would be very rare to get a subject quote from a market maker. The most common case is when a customer calls her registered rep and asks, "how is ABCD doing today?" The rep could respond "last time I looked, it was 38 to a half" or "I think it is about 38-38.50" The statement is clear that the prices might have changed. As we showed you phraseology used to indicate a firm quote, the phrasing used to indicate a subjet quote might be tested as well.

Analyzing Long Margin Accounts

To analyze long margin account activity, a simplified balance sheet will be used, as shown as follows. The LMV is an asset, the DR is a liability, and the difference between them is the equity. TO meet the margin requirements, it is either cash amount of the requirement, or if using fully paid securities, it is double the requirement. When the market value of securities changes, the BD must mark to market the positions to ensure that enough equity remains in the account. The customer's account must always meet the MAINTENANCE REQUIREMENT of FINRA. In a long margin account, minimum maintenance is 25% of the LMV. Marking to the market identifies the status of the customer's account. The determination of the status requires the computation of two benchmarks: REGULATION T (50% of LMV) MINIMUM MAINTENANCE (25% of LMV) **Some helpful tips in Long Margin Accounting: -When the market value of securities goes up or down, the DR does NOT change. -When marking to the market, the calculation of Reg T and minimum maintenance is based on the new LMV

Margin Deposits

To borrow shares for short sales, an investor must make MARGIN DEPOSITS. REG T specifies that the initial margin for short sales can be met with either cash or marginable securities, just as in long margin transactions. B/c the short seller is obligated to replace the borrowed shares, sufficient cash (or buying power) must be made in the account at all times to enable the BD to purchase the necessary shares if the customer is unable to do so. The Series 7 uses the following terms to describe activity in short margin accounts: -Short Market Value (SMV): The current market value of the stock position the investor sells short. -Credit Register (CR): The amount of money in the customer's account; equal to the sales proceeds plus the margin deposit requirement. Think of this as a credit balance in the account. -Equity EQ: The customer's net worth in the margin account; the amount by which the credit balance exceeds the current SMV of the securities in the account. **The amount of equity in the account is determined by this equation: CR - SMV = EQ**

Day Orders

Valid only until the close of trading on the day it was entered. If it has not been filled, the order is cancelled at the close of the day's trading.

Maintenance Requirements

Wen the equity in the account falls below the maintenance requirement, the customer receives a MAINTENANCE MARGIN CALL. These calls are a demand that the customer make a payment to bring the account back to minimum. Failure to meet the call immediately requires the BD to liquidate enough securities in the account to bring the account back to minimum. There are two ways that a customer can meet the margin maintenance call: -Depositing cash -Fully paid marginable securities A firm can impose a maintenance level higher than the FINRA minimum maintenance rule levels. This is a HOUSE MINIMUM. Many firms today impose 30-35% min requirements. TTA*** It is critical to remember that REG T imposes margin requirements for new securities transactions and for withdrawals of cash or other collateral. Reg T does not otherwise establish any requirements relating to the amount of margin that must e maintained in a customer's account after it has bought (or sold short) one or more securities. The rule on maintenance equity are solely those of the SROs.

Bids Offers and Quotes

When a customer buys a stock from a firm acting as principal, the broker marks up the ask price to reach the net price to the customer. Same for when a customer sells stock to a firm acting as principal, the dealer marks down from the bid price to reach the net proceeds to the customer. Customer buying the stock from a broker acting as principal, the firm adds a markup to the cost. If the broker is acting as an agent, and charge the customer the same price it paid plus a commission. Customer selling to a broker acting as principal, the princiapl buys from the customer and sells to the market maker at the bid price. Since the price paid to the customer is less than the broker receives from the market maker, the broker "marked down" the customer. If the broker acts as an agent, crediting the customer with the market maker's bid price, less the commission. *****A BD can never charge a markup (or markdown) and a commission on the same trade. One or the other, but never both*****

Options and Margin

With the exception of LEAPS options, options are NOT marginable securities. When buying options, customers must deposit 100% of the premium. When buying a stock on margin and then writing a covered call, there is no REG T requirement for the call option. All the customer must do is have 50% of the purchase price of the stock in the account. If you see a margin question on covered call writing, be sure to focus on what is being asked: is it the REG T requirement, or is it the margin deposit? With regard to option spreads, REG T requires customers to deposit the maximum loss. In debit spreads, the net debit represents the maximum loss. In credit spreads, subtract the net credit from the different between the strike prices to determine maximum loss.

Limit Orders

a customer limits the acceptable purchase or selling price. Can be executed only at a specific price or better. If the order can't be executed at the limit price immediately, it is placed on the designated market maker's (DMM's) book and executed when and if the market price meets the order limit price. Buy limit orders are placed below the current market, whereas sell limit orders are placed above the current market price. Buy limit orders are used by investors who believe the stock is currently overpriced but would like to buy the stock on a dip in the market. Investors who own stock and believe it is currently under valued turn in a sell limit order getting them out of the position should the stock rise to a desired level.

Market Orders

are sent immediately to the trading floor for execution. without restriction or limits. They are executed immediately at the current market price and have priority over all other types of orders. A market order to buy is executed at the lowest offering price available; a market order to sell is executed at the highest bid price available. Those prices are referred to as the INSIDE MARKET or INSIDE QUOTE. As long as the security is trading, a market order guarantees execution. When the objective of the client is immediate execution, use a market order.

At-the-Open and Market-on-Close Orders

ato orders are executed at the opening of the market. PARTIAL executions are ALLOWABLE.They must reach the post by the open of trading in that security or they will be canceled. moc orders are executed at or as near as possible to the closing price in the OTC market. On the NYSE, however, a moc order must be entered before 3:40 pm ET and will be executed at the closing price.

Hypothecation Agreement

gives permission to the BD to pledge customer margin securities as collateral. The firm hypothecates customer securities to the bank, and the bank loans money to the BD on the basis of the loan value of these securities. ALl customer securities must be held in STREET NAME (registered in the name of the firm) to facilitate this process. When customer securities are held in street name, the BD is known as the NOMINAL or NAMED OWNER. The customer is the BENEFICIAL OWNER, b/c he retains all rights of ownership. After customers pledge their securities to the BD by singing the hyp agreement, the BD rehypothecates (repledges) them as collateral for a loan from the bank. Regulation U oversees the process when a bank lends money to a BD based on customer securities that have been pledged as collateral. BDs are limited to pledging 140% of a customer's debit balance as collateral. Any customer securities in excess of this amount must be physically segregated. The firm cannot commingle customer securities with any securities owned by the firm. Firms can only commingle one customer's securitites with another customer's securities for hypothecation if customers have given specific permission by signing the hypothecation agreement.

Regulation SHO

mandates a locate requirement. That means that before the short sale of any equity security, firms must locate the securities for borrowing to ensure that delivery will be made on the settlement date. Not doing so is known as naked short selling and is not permitted.

Quotation Spread

The difference between a security's bid and offer (ask) price is known as the spread.

COD Trades

Delivery versus payment and Receipt versus payment accounts.... those are accounts, primarily for institutional clients, where the delivery of securities purchased is made to a third party acting as an agent for the purchaser. This third party is usually a bank and holds the institution's money. Payment is made upon delivery to the agent. RVP is the opposite--the agent delivers the securities concurrent with the payment by the purchaser. FINRA RULE 11860 refers these as COLLECT ON DELIVERY (COD) and payment on delivery (POD) transactions. Members can't accept an order on a COD or POD unless members follow all of the FINRA rule procedures as follows: -The member shall have received from the customer prior to or at the time of accepting the order, the name and address of the agent and the time and account number of the customer on file with the agent and institution number, where appropriate. -Each order accepted from the customer pursuant to such an arrangement has noted thereon the fact that it is a POD or COD transaction. -The member shall deliver to the customer a confirmation, or all relevant data customarily contained in a confirmation with respect to the execution of the order, not later than the close of business on the next business day after any such execution. -The member shall have obtained an agreement from the customer that the customer will furnish its agent instructions with respect to the receipt or delivery of the securities involved in the transaction promptly upon receipt by the customer of each confirmation. Trades in these accounts qualify for a special rule under REG T. If a BD purchases for or sells to a customer a security in a delivery against payment transaction, the BD has up to 35 calendar days to obtain payment if delivery of the security is delayed b/c of the mechanics of the transaction and is not related to the customer's willingness or ability to pay.

Deadlines for Meeting Margin Calls

The deposit to meet initial margin requirements may be made in cash or in fully paid marginable securities valued TWICE (200%) the amount of the Regulation T cash call. If payment is late, the BD may apply to its Designated Examining Authority (DEA) for an extension. The DEA for a BD can be either FINRA, an exchange, or, in some cases ,the Federal Reserve Bank. For introducing BDs, the request is made by the firm that does their clearing (back office work). A BD may, at its option, disregard any sum due from the customer not exceeding $1,000. That does not mean the firm ignores the debt, it means the sell out and freeze does not have to take place. If no extension is received by the morning of the 3rd business day after the settlement date, (one day after the deposit must be made) the firm must sell out the securities purchased and freeze the account for 90 days. If the customer wants to purchase securities in a frozen account, the customer must have full payment in the account before order entry. Freeriding is a term used when securities are purchased and then sold without making payment for the purchase on settlement date. Freeriding is generally prohibited in both cash and margin accounts. As a penalty, the account will be frozen for 90 days. and no new transactions can occur unless there is cash or marginable securities in the account before the purchase is made. **Freeriding can be avoided by: -They can have sufficient funds in their account before making the trade. -"swap" checks on settlement date. That is, pay the BD and then receive payment for the sale.

Long Margin Accounting (The Customer Owns the Security)

The exam uses the following terms to describe activity in long margin accounts: -Long Market Value (LMV). The current market value of the stock position the investor purchased. -Debit register (DR). The amount of money borrowed by the customer. -Equity (EQ). The customer's net worth in the margin account; it represents the portion of the securities the customer fully owns. The amount of equity in the account is determined by this equation: LMV - DR = EQ To simplify long margin accounts, think of them as a house with a mortgage. If the market value of a house goes up or down, the mortgage amount does not change., but the equity goes up or down. The same is true in a margin account; when the market value of securities goes up, the debit balance stays the same while the equity increases. When market value of the securities goes down, the debit balance stays the same and the equity decreases. When money is paid into a margin account, the debit balance is decreased, and the equity is increased.

Minimum Maintenance in a Short Account

The minimum maintenance margin requirement for short accounts is 30%. However, there are exceptions based on price per share: -For stock trading under $5 per share, a customer must maintain 100% of SMV or $2.50 per share, whichever is greater. -for stock trading at $5 per share and above, the minimum requirement is the greater of $5 per share or 30% or the short market value. As a practical matter, only when the SMV exceeds $16.67 will the requirement be 30%

Firm Quote

The price at which a market maker stands ready to buy or sell at least one trading unit--100shares of stock or 5 bonds-- at the quote price with other member firms. When a FINRA member firm makes a market in a security, the BD must be willing to buy or sell at least one trading unit of the security at its firm quote. All quotes are firm quotes unless otherwise indicated. One function of an employee of a BD is that of OTC trader. This individual is responsible for taking customer orders received in the trading department and getting them executed at the best possible price. This trader may attempt to negotiate a better price with a market maker by making a counteroffer for a counterbid, especially if the spread between the market maker's bid and ask is fairly wide. However, the only way to guarantee an immediate execution is to buy stock at the market maker's ask price or sell at the bid price. A market maker might give another BD a quote that is firm for an hour with 5 minute recall. This is a firm quote taht remains good for an hour. If, within that hour, the market maker receives another order for the same security, the trader calls the BD back and gives it five minutes to confirm its order or lose its right to buy that security at the price quoted.