S66 Unit 23 (Trading Securities) Quiz
The SROs have instituted maintenance margin levels for those situations where the equity in a client's margin accounts is reduced to a dangerous level. Currently, those levels are A) 25% for a long account. B) 25% for a short account. C) 30% for a long account. D) 50% for a long account.
A) 25% for a long account. Explanation The current minimum maintenance levels set by the SROs is 25% equity in a long margin account and 30% equity in a short margin account. The initial margin requirement under Reg. T is 50% for both long and short accounts. LO 23.b
One of your clients enters a sell stop order at 60, limit 59. Subsequent to the entry of the order, trades occur at 61, 61.10, 60, 58.95, 59, 60. The client's order was most likely filled at A) 59 B) 60 C) 61.10 D) 58.95
A) 59 Explanation This is really two orders. The first is to "stop" at 60. That is, once the stock trades at 60 or lower, enter the order. The second order is a sell, but with a limit of 59. In this sequence, the first time the stock hits 60 (or less), is the 3rd trade, the one at 60. That triggers the sell limit. The next trade is at 58.95 and that is not acceptable to the limit order at 59. Why not? Because the limit order is saying, "get me 59 or higher"; that makes the following trade at 59 an acceptable price. LO 23.f
Which of the following takes place on the New York Stock Exchange? A) Buying and selling stocks on the secondary market B) Buying and selling of Nasdaq stocks C) Buying and selling stocks on the over-the-counter (OTC) market D) Buying and selling stocks on the primary market
A) Buying and selling stocks on the secondary market Explanation The secondary market is the market in which securities are traded after they are issued to the public. The secondary market takes place on exchanges, such as the New York Stock Exchange (NYSE), and on the over-the-counter (OTC) market. The OTC market is the market for securities that are not traded on an exchange. . LO 23.c
Opening a margin account involves significant documentation. Which of those documents discloses the interest rate charged by the broker-dealer, including the method of interest computation and situations under which interest rates may change? A) The credit agreement B) The loan consent agreement C) The interest computation agreement D) The hypothecation agreement
A) The credit agreement Explanation It is the credit agreement that discloses the terms of the credit extended by the broker-dealer, including the method of interest computation and situations under which interest rates may change. LO 23.a
A "margin account" is a type of brokerage account in which the broker-dealer lends the investor cash to purchase securities using marginable securities in the account as collateral. Which of the account documents authorizes the use of those securities as collateral for that loan? A) The hypothecation agreement B) The secured agreement C) The credit agreement D) The loan consent agreement
A) The hypothecation agreement Explanation The hypothecation agreement permits the broker-dealer to accept the client's margin securities as collateral for the loan that the BD makes to the investor. It also permits the BD to re-hypothecate those securities as collateral for a loan that it takes out to provide the money for the loan it makes to the investor. In simple terms, there are two loans taking place under the hypothecation agreement: 1) The loan from the BD to the client with the client's securities used as collateral. 2) The loan from a bank to the BD with the client's securities used as collateral for the BD's loan. LO 23.a
When discussing a stock exchange, a specialist is A) a member of the New York Stock Exchange who executes orders for other members and who also acts as a market maker charged with the responsibility of keeping an orderly market in designated stocks B) an electronic brokerage concern that executes trades online and through specialized trading order executing services C) a floor broker on the New York Stock Exchange who only executes trades for other brokers in return for commissions D) a trader who makes a market in OTC stocks and ADRs
A) a member of the New York Stock Exchange who executes orders for other members and who also acts as a market maker charged with the responsibility of keeping an orderly market in designated stocks Explanation A specialist is a member of the NYSE who executes orders for other members and who also acts as a market maker charged with the responsibility of keeping an orderly market in designated stocks. A specialist must have sufficient capital to buy and sell from his own account in order to maintain a liquid and orderly market. The term specialist has been replaced by designated market maker (DMM), but it seems that specialist may still be in use on the exam. A trader who makes a market in OTC stocks and ADRs is a market maker in the OTC market and not a specialist on an exchange. A specialist executes trades on an exchange. LO 23.c
One of the primary differences between trading on listed exchanges and trading in the over-the-counter market is that only on the exchanges are prices determined A) by an auction process. B) by the exchange itself. C) through a negotiation process. D) by the FINRA 5% markup policy.
A) by an auction process. Explanation One of the chief characteristics of exchange markets is the auction process for determining the price of a security. In the OTC markets, prices are determined by negotiation. The stock exchanges do not set the price, and although FINRA's markup policy is used to determine the charges to customers, that is separate from determining the security's price. LO 23.c
Large investors, such as hedge funds or institutions, using high-speed systems to monitor and submit large number of orders to the markets are engaging in A) high frequency trading. B) market manipulation. C) market making. D) front running.
A) high frequency trading. Explanation This is the definition of high frequency trading (HFT). Trading speed is measured in microseconds (a microsecond is equal to one millionth (0.000001) of a second. It is not considered market manipulation, although the regulators have uncovered cases where there were phony trades designed to manipulate market prices. Front running is when a securities professional enters an order for a personal account ahead of a large order just received. LO 23.g
Some market makers, in an attempt to increase order flow, will pay other broker-dealers for routing customer orders to them. This is known as A) payment for order flow. B) interpositioning. C) third-party payments. D) soft-dollar compensation.
A) payment for order flow. Explanation Payment for order flow can be beneficial for small firms that cannot handle large numbers of orders. Pulling together lots of orders and sending them to another firm to be executed can help keep costs down. The market maker benefits from added share volume enabling it to compensate the firms directing the business its way. When acting in an agency capacity for a customer, a BD cannot place a third party between itself and the best available market; they must go directly to the market maker. That is the unethical practice of interpositioning (and is an example of the exam using a term that you likely don't know as a distractor). Soft dollar compensation is between a BD and an investment adviser and, unlike payment for order flow, does not consist of a monetary payment, hence the term soft dollar. LO 23.e
According to standard terminology used in the securities industry, when a person sells securities out of inventory, that person is acting in the capacity of a (an): A) principal. B) broker. C) agent. D) investor.
A) principal. Explanation In any transaction, there are two principals - the buyer and the seller. When a person sells securities out of inventory, they are acting in a principal capacity. LO 23.d
A customer representing an institution calls the securities agent to complain that a security bought one year ago is showing a loss. The customer's job will be lost unless he is able to get out of the security at breakeven or a small loss. The market is 78-81 in the security and the customer's cost is 85. The agent can legally: A) sell the security at the best available bid price in the market B) offer to buy the security at 85 if the customer agrees to buy another security in its place C) buy back the security at 85 and place another security in the account at a price high enough to cover the loss D) execute the trade at 81, but show the confirmation at 85
A) sell the security at the best available bid price in the market Explanation While the agent's inclination might be to repurchase this security, the Uniform Securities Act states that such an act may be fraudulent. It also states that any market or price manipulation of a security or any false quotations of executed trades is strictly forbidden. The only appropriate action is to attempt to obtain the best execution for the client. That would mean selling at the best available bid price in the market. LO 23.e
To fill a customer buy order for 800 WXYZ shares, your firm requests a quote from a market maker. The response is "bid 15, ask 15.25." If the order is placed, the market maker must sell A) 800 shares at no more than $15 per share B) 800 shares at $15.25 per share C) 800 shares at $15 per share D) 100 shares at $15.25 per share
B) 800 shares at $15.25 per share Explanation A market maker is responsible for honoring a firm quote. If no size is requested by the inquiring trader, a quote is firm for 100 shares. In this example, the trader requested an 800-share quote, so the market maker is responsible for selling 8 round lots of 100 shares at the ask price of $15.25 per share. LO 23.e
All investing carries risk of loss. Some positions have much higher risk than others. Among the riskiest is selling stock short. Which of the following types of orders would you recommend to a short seller as a potential hedge against loss? A) Sell stop B) Buy stop C) Buy limit D) Sell limit
B) Buy stop Explanation The risk to a short seller is to the upside (there is, at least theoretically, no limit as to how high the stock's price can go). Remember, a short seller is obligated to buy back the shorted stock. Therefore, we want to place an order that will enable the customer to purchase the stock before the price rises too high. That reduces the choices to the two that include the word, buy (we've already sold the stock, selling it again doesn't help). To protect against an increase to the stock's price beyond the point the investor is willing to lose, it is wise to enter a buy stop order at that price. If the stock should reach that price, the order is triggered, a market order is entered, and the short position is closed out. This is why stop orders are usually referred to as stop loss orders; they keep you from losing any more money. A buy limit order is always placed below the current market. That won't help the short seller when the price of the stock rises. LO 23.f
Which of the following best describes thinly traded stocks? A) They usually have less volatile price swings than actively traded stocks. B) They are either not actively traded on an exchange or not held by a large number of investors. C) They are usually highly liquid and marketable. D) They are actively traded on an exchange and held by a large number of investors.
B) They are either not actively traded on an exchange or not held by a large number of investors. Explanation Thinly traded stocks are stocks that are not actively traded on an exchange or that are not held by a large number of investors. Because thinly traded stocks are usually less marketable and less liquid than actively traded stocks, the spread between their bid and ask prices tends to be considerably higher. They also tend to have more volatile price swings. LO 23.e
The Securities Exchange Act of 1934 defines a market maker is A) an agent for the issuer B) a dealer who, with respect to a security, holds himself out as being willing to buy and sell that security for his own account on a regular or continuous basis C) an agent whose clients are institutions D) a person who buys and sells securities for her own account or for the accounts of others
B) a dealer who, with respect to a security, holds himself out as being willing to buy and sell that security for his own account on a regular or continuous basis Explanation A market maker is a dealer who holds himself out as being willing to buy or sell a security at a quoted price on a regular and continuous basis. LO 23.d
One of your clients has a margin account. There is a drop in the value of the stock owned in the account, and additional funds are required based on the terms of the firm's margin agreement. This would be known as A) a sellout B) a house call C) a Regulation T call D) a margin call
B) a house call Explanation When additional funds are required, it is known as a house or maintenance call. If based on the firm's stricter requirement, it is a house call; if based on the requirement of the SRO, it is a maintenance call. The initial or Regulation T call (the margin call) occurs at the time of the purchase. If any call for funds is not met, then there will be a sellout. Remember the three important margin terms: Margin call: Set by the Federal Reserve Board under Regulation T. This is the initial 50% deposit required when purchasing securities on margin. Minimum maintenance: Set by the SROs. This is the minimum equity that must be maintained in a margin account. Should the equity fall below the minimum required, a maintenance call (sometimes called maintenance margin) will go out demanding an immediate deposit of enough equity to bring the account above the required level. House maintenance: Set by the individual broker-dealer firm. As a cushion, and to reduce the possible sellout caused by failure to meet a maintenance call, most firms set a minimum equity level above the SRO minimum. Falling below this amount triggers a house call. LO 23.b
The general rules dealing with a broker-dealer extending credit for a customer to purchase securities are found in Regulation T of the Federal Reserve Board. However, Regulation T does not address A) initial margin requirements B) maintenance margin C) mixed margin accounts D) loan value of securities
B) maintenance margin Explanation Maintenance margin levels are set by the SROs, such as FINRA. They are currently 25% for long accounts and 30% for short accounts (you will not have to calculate these). LO 23.b
A securities trade is made. Under normal circumstances, all of the following would be noted on the order ticket except A) the registered agent who accepted the order B) the name of the individual who transmitted the order C) the time stamp of the time of order submission D) the account number
B) the name of the individual who transmitted the order Explanation Transmitting an order is a clerical function, and we don't put that on the order ticket. A typical ticket will include the account for which the trade is being made, the registered individual placing the order for the client, time stamps for entering and execution (or cancellation), execution price, and terms and conditions of the order (market, limit, etc.). LO 23.f
A broker-dealer receives a request from a client to purchase an OTC stock. When the broker-dealer's trading department contacts the market maker in the stock, she receives a quote of 35 − 35.25, 7 by 9. Based on this information, the spread is A) $2 B) $0.63 C) $0.25 D) within the allowable range of NASAA's 5% markup policy.
C) $0.25 Explanation The spread is the difference between the bid (35) and the ask (35.25) prices. In this question, that is 25 cents ($0.25). The 7 by 9 means that the market maker is willing to buy up to 700 shares at the $35 bid and sell up to 900 shares at the $35.25 ask. NASAA does not have a markup policy; the 5% Policy is FINRA's.
In order to be considered a block trade, an order for common stock must be for at least A) 100 shares B) 100,000 shares C) 10,000 shares D) 1,000 shares
C) 10,000 shares Explanation In the industry, the term block trade refers to a common stock transaction involving at least 10,000 shares. LO 23.f
Which of the following is an order to purchase at higher than the current market? A) A buy limit B) A buy, fill, or kill C) A buy stop D) A buy, immediate or cancel
C) A buy stop Explanation Buy stop orders are entered above the current market value of the stock. LO 23.f
A broker-dealer must provide a risk disclosure document to a customer before opening which of the following accounts? A) Wrap fee B) Joint C) Margin D) Custodial
C) Margin Explanation All customers opening margin accounts must receive a risk disclosure document describing the risks associated with trading on margin (e.g., a customer could lose more than the initial investment, or the firm could sell out securities in the account to meet a maintenance call without providing prior notice to the customer). This document must also be provided to customers on an annual basis. LO 23.a
Under the Securities Exchange Act of 1934, which body regulates the extension of credit for nonexempt securities? A) The Comptroller of Currency B) The New York Stock Exchange C) The Federal Reserve Board D) The SEC
C) The Federal Reserve Board Explanation The Securities Exchange Act of 1934 empowered the Federal Reserve Board (FRB) to set margin requirements and regulate the use of credit to purchase securities. The FRB determines what issues may be purchased on margin and what percentage of the purchase price must be deposited by the purchaser. LO 23.a
Which of the following statements is true about sales of new issues under the Securities Exchange Act of 1934? A) Installment payments are allowed on purchases. B) The SEC determines what issues may be purchased on margin. C) The use of credit to purchase new issues is prohibited for the first 30 days. D) Credit may be used in purchasing new issues.
C) The use of credit to purchase new issues is prohibited for the first 30 days. Explanation The Securities Exchange Act of 1934 specifically bars the use of credit in purchasing new issues for the first 30 days from the date of issue. In addition, it prohibits installment payments on issues that can be bought on margin. The Securities Exchange Act of 1934 also empowered the Board of Governors of the Federal Reserve Board (FRB) to set margin requirements, and the FRB determines which issues may be purchased on margin. LO 23.a
A client of a broker-dealer turns in an order to purchase 10,000 shares of XYZ stock on the NYSE. This would be A) front running B) churning C) a block trade D) arbitrage
C) a block trade Explanation In the securities business, trades of 10,000 shares or more are known as block trades. LO 23.f
Nite Capital Group is a registered broker-dealer whose primary business model is providing quotations for OTC stocks in which they position trade. Nite would be known as A) a secondary market B) an investment company C) a market maker D) a specialist
C) a market maker Explanation A market maker is a firm that stands ready to buy and sell a particular stock on a regular and continuous basis at a publicly quoted price. The term is most often used in the context of the over-the-counter (OTC) markets. Market makers trade for their own inventory (position trade). The term specialist historically referred to the person on the floor of a stock exchange who performed a similar function; the current term is designated market maker (DMM). LO 23.d
An investor owns a long-term U.S. Treasury bond with a 6% coupon and 21 years to maturity. The client wishes to sell and receives a quote from a dealer of 96.13. This number represents A) the markdown B) the offer price C) the bid price D) the discount
C) the bid price Explanation If you want to sell, the dealer will pay you his bid price. Had the question said the client wanted to buy, the quote would have been the offer (ask) price. What does the 6% coupon and the 21 years to maturity have to do with the question? Nothing. Knowing that treasuries are quoted in 32nds has nothing to do with it either. Also, the price quote is below 100 so it is at a discount, but the better answer is bid price because the question is referring to the quote. LO 23.e
A buy stop order may be used for all of the following except A) to acquire a long position as a stock breaks through resistance B) to protect against loss in a short position C) to protect a profit in a long position D) to protect a profit in a short position
C) to protect a profit in a long position Explanation Buy stop orders go into effect when the price of the security reaches or exceeds the specified "stop" price. As such, they are commonly used by short sellers who either wish to protect a profit they've already made, or protect against a loss if the stock should go up. Buy stops can also be used by those wishing to acquire stock when it breaks through a resistance level. However, when one is already long the stock, turning in an order to buy more is not going to offer any protection. LO 23.f
An investor has issued the following orders to her agent when GMB Corp. is trading at $29 and RML Corp. is trading at $17: 1) Buy 200 shares of GMB if the price should increase to $31 2) Sell 400 shares of RML for at least $18 The investor has issued what types of orders? GMB RML A) Buy stop Sell stop B) Buy limit Sell limit C) Buy stop Sell limit D) Buy limit Sell stop
C) Buy stop & Sell limit Explanation An order to buy a stock when it goes up to a specified price is a buy stop order. An order to sell a stock where the investor gives the agent a minimum acceptable price is a sell limit order. LO 23.f
A client enters an order as follows: Sell stop 100 shares of LTC at 45 limit 45.50. Following the entry of that order, trades occur in the following sequence: 47; 46; 45.12; 44.97; 45.28; 45.97; 46.05. More than likely, the client received A) 44.97 B) 46.05 C) 45.28 D) 45.97
D) 45.97 Explanation This is really two orders. The first is to stop at 45. That is, once the stock trades at 45 or lower, enter the order. The second order is a sell, but with a limit of 45.50. So the first time the stock hits 45 (or less) is the trade at 44.97. That triggers the sell limit. The next trade is at 45.28 and that is not acceptable to the limit order at 45.50. Because the limit order is saying, "get me 45.50 or higher," the 45.97 is an acceptable price. LO 23.f
The procedure for entering an order to purchase a security for the account of a customer is to complete an order ticket. Which of the following would be found on an order ticket? A) Customer name, customer address, execution price, and time of execution or cancellation B) Account number, customer address, time of order entry, and terms and conditions of the order C) Customer name, execution price, time of order entry, and time of execution or cancellation D) Account number, execution price, time of order entry, time of execution or cancellation, and terms and conditions of the order
D) Account number, execution price, time of order entry, time of execution or cancellation, and terms and conditions of the order Explanation This is one of those questions where the best way to find the answer is by determining what is not correct. Customer name and/or address would never be on an order ticket and that knocks out three of the choices. The account number (not name), the execution price (once the order is completed), the time of entry and execution (or cancellation if it is a day order that is not executed), and the terms and conditions (limit, market, stop, etc.) are all on the order ticket. LO 23.f
Which of the following positions would create the most risk for an investor? A) Buy 100 shares of SSS and sell 1 SSS call. B) Sell short 100 shares of SSS and buy 1 SSS call. C) Buy 100 shares of SSS and buy 1 SSS put. D) Sell short 100 shares of SSS and sell 1 SSS put.
D) Sell short 100 shares of SSS and sell 1 SSS put. Explanation In the securities industry, there are two strategies that present an unlimited loss potential. Those two are a short sale of stock and selling an uncovered call option. In a short sale, the investor has borrowed stock, and that stock must eventually be returned. That means buying it in the open market, and, because there is no limit on how high the price of a stock can go, the potential loss is infinite. If the short seller also sells a put option, a premium will be received. If the stock price rises above the strike price, the put option will expire and the seller will keep the premium. Even though the premium is now in the pocket of the short stock seller, the potential loss is infinity minus the premium and that is still infinite. Short stock sellers protect themselves from this problem by going long a call option in the stock. That gives them a guaranteed buy-back price (the strike price of the call). Buying 100 shares of a stock and then writing a call on it is a covered call with limited loss. Buying stock and buying a put carries a maximum loss of the combined purchase prices. LO 23.f
It is often said that the backbone of the over-the-counter market is the market maker. A good description of a market maker would be A) a broker-dealer who stands ready to buy or sell at least the standard unit of a specific stock traded on a listed exchange B) an investment banker who participates in a firm underwriting C) a member of FINRA D) a broker-dealer who stands ready to buy or sell at least the standard unit of a specific stock traded in the over-the-counter market
D) a broker-dealer who stands ready to buy or sell at least the standard unit of a specific stock traded in the over-the-counter market Explanation This is the basic definition of a market maker. Specialists perform essentially the same service on the listed exchanges. Although all OTC market makers are members of FINRA, being a FINRA member does not define a broker-dealer as a market maker. LO 23.c
If a client places an order to buy 300 DWQ at 140 stop, but not over 144, and the order is left with a specialist, this is A) a buy limit order B) a buy stop order C) a market order D) a buy stop limit order
D) a buy stop limit order Explanation The customer has placed a buy stop limit order. If the stock rises to the stop price of $140, the order will be triggered and becomes a buy limit order at $144, meaning an order to buy at $144 or better (lower). LO 23.f
An exchange specialist is A) a floor broker on the New York Stock Exchange who only executes trades for other brokers in return for commissions B) a trader who makes a market in OTC stocks and ADRs C) an electronic brokerage concern that executes trades online and through specialized trading order executing services D) a dealer on the New York Stock Exchange who executes orders for other brokers and who also acts as a market maker with the responsibility of keeping an orderly market in designated stocks
D) a dealer on the New York Stock Exchange who executes orders for other brokers and who also acts as a market maker with the responsibility of keeping an orderly market in designated stocks Explanation A specialist (more accurately a designated market maker - DMM, but NASAA may not use the current term on the exam) is a dealer on the NYSE who executes orders for other brokers and who also acts as a market maker with the responsibility of keeping an orderly market in designated stocks. A specialist must have sufficient capital to buy and sell from his own account in order to maintain a liquid and orderly market. LO 23.c
An order to sell securities where immediate execution is more important than price is called A) an unsolicited order B) a discretionary order C) a limit order D) a market order
D) a market order Explanation The market order is executed as soon as possible at the best price in the market at that moment. Limit orders specify a price. LO 23.f
When a brokerage firm sells stock from its own inventory, it is acting in the capacity of A) a principal, and charges a commission B) an agent, and charges a markup C) an agent, and charges a commission D) a principal, and charges a markup
D) a principal, and charges a markup Explanation A broker-dealer that purchases securities for, or sells securities from, its inventory is acting in the capacity of a principal. Principals charge markups on sales from inventory. When acting in the capacity of agent (facilitating a transaction between a buyer and seller), the broker-dealer receives a commission. LO 23.d
Large investors, such as hedge funds or institutions, using high-speed systems to monitor and submit large number of orders to the markets are engaging in A) market making. B) front running. C) market manipulation. D) high frequency trading.
D) high frequency trading. Explanation This is the definition of high frequency trading (HFT). Trading speed is measured in microseconds (a microsecond is equal to one millionth (0.000001) of a second. It is not considered market manipulation, although the regulators have uncovered cases where there were phony trades designed to manipulate market prices. Front running is when a securities professional enters an order for a personal account ahead of a large order just received. LO 23.g
All of the following are advantages of a margin account except A) leveraging is possible B) money is borrowed C) less cash is needed to purchase securities D) losses are minimized
D) losses are minimized Explanation The leveraging involved through the use of borrowed money works both ways. Gains are magnified, but so are losses. In fact, in a margin account, the investor can lose more funds than have been deposited into the account. LO 23.a
An investor purchased 100 shares of GRA stock at $100 per share in a margin account. Two years later, the GRA was sold for $120 per share. If the investor's account was charged $700 in margin interest, it would be proper to state that this is an example of A) a speculative investment. B) negative margin. C) a long-term capital gain of $1,300. D) positive margin.
D) positive margin. Explanation Positive margin means that, after taking into consideration the interest paid on the borrowed money in a margin account, a specific transaction was profitable (negative margin is the reverse). In this case, the sale resulted in a long-term capital gain of $2,000 (100 shares at $120 = $12,000 proceeds less 100 shares at $100 = $10,000 cost), which is $1,300 more than the interest cost. LO 23.b
