SIE Exam Ch. 12

GTC/open order

an order that remains in effect on a broker-dealer's order book until its either executed or cancelled. Any firm that accepts these orders should periodically update them with the exchanges. Must also be updated due to any partial fills. A customer may enter an order that's good for a week, a month, or another specified time. If the order is not executed by the end of the specified time, the customer's brokerage firm will simply cancel it

Exemptions

securities that require the delivery of a prospectus or offering circular are exempt from the provisions of the 5% policy because these primary issuances are sold at a specific public offering price. These include IPOs, municipal bonds, and mutual fund shares

Day order

unless otherwise specified, every order is considered a day order and will be available for execution from 9:30am to 4:00pm ET. If the order is not executed during the normal trading day, it's cancelled at the end of the day

Factors that influence the level of markups

- the type of security involved (ex. common stocks or limited partnership units carry higher markups than bonds) - the availability of the security in the market (the more effort it takes to locate a specific security, the higher the markup) - the price of the security (percentage of markup generally increases as the price of the security decreases b/c low priced securities may require more handling and expense) - the amount of money involved in a transaction (small total dollar amounts may require greater handling expenses on a proportionate basis than larger transactions) - disclosure (disclosing that circumstances may warrant a higher markup) - the pattern of markups (FINRA punishes firms that consistently charge excessive markups. Need to be justified for each case) - the nature of the broker-dealer's business (additional services provided may warrant higher markups)

Agent/dealer summary

Broker - agent - do not assume risk - earns commission Dealer - principal - assumes risk - earns markup or markdown A B C P D M

The 5% Markup Policy

FINRA members are prohibited fro charging prices or commissions that are unfair or excessive, so this policy was developed. Although stated in terms of a markup, this policy applies to markups, markdowns and commissions. Applies when a broker-dealer is acting in an agency or principal capacity for transactions involving both exchange-listed and non-exchange-listed securities. Ex. market price of a share is $20, broker/dealer sells it for $21 (taking a $1 per share markup is exactly 5%). But, need to consider all relevant factors. Is a general guideline - can justify higher or lower

Margin requirement

Short sales must be executed in a margin account. Brokerage firms provide short sellers with stock that has been borrowed from other margin customers. However, the other margin customers must provide permission for the firm to lend their securities to short sellers. The permission is obtained through the signing of a loan consent agreement at the time that the account is opened. As long as the short seller's margin account maintains the minimum required equity, there is no set time by which the short seller must repurchase the borrowed shares. While maintaining a short position, if a cash dividend is paid on the borrowed stock, the short seller is responsible for paying the dividend to the lender

Unsolicited

the trade was the client's idea

Brokers (agents)

attempting to find the other side of the trade on behalf of its client. If a client wants to buy, they find a seller. If a client wants to sell, they find a buyer. They are not buying or selling shares for their own account; instead, they try to find a buyer/seller for their customers. "Broker" trades. Charge commissions

Order qualifiers

day order good-'til-cancelled (GTC) or open order

Discretion not exercised

if a client consents to a specific trade recommendation before execution. Must be checked off by RR. Not the same as unsolicited

Discretionary order

if a client has granted discretionary authority to his registered representative, this should be indicated for each of these. Discretionary trades have more heightened supervisory requirements

Stop price

if the market reaches this, the stop order is activated and becomes a market order to buy or sell. Since an activated stop order becomes a market order, the investor is guaranteed that the order will be executed; however, there's no guarantee as to the price of execution

Bids and offers are posted

in round lots of 100-share multiples

Odd lots

investors trading less than 100 shares

Market order

most basic type of order; a client does not specify a price. Instead, the order will be executed at the best available price when the order is entered (i.e. the highest bid for market orders to sell and the lowest offer for market orders to buy). Although these will be immediately executed, the client is not assured of a specific execution price. These are often used for stocks that have active (liquid) markets in which the spread (difference between the bid and ask price) is narrow

Proceeds transactions

occurs when a customer directs a member firm to sell a security and use the proceeds of the sale to buy another security. For these transactions, the member firm must follow the 5% policy and compute the markup as if the customer had purchased the securities for cash. Therefore, the compensation received on the customer's sale is added to the compensation that the firm received on the customer's purchase. In other words, the charge assessed on the liquidation is added to the charge for the subsequent purchase. Ex. if a customer instructs the firm to sell $5,000 of ABC stock and use the proceeds to purchase $5,000 of XYZ stock, the firm must compute the markup using its total compensation from both the sale and purchase as a percentage of $5,000

Stop (loss) orders

often entered by customers who are trying to prevent a large loss or protect a profit on an existing stock position. In most cases, these investors would rather not receive execution on their stop orders. Contingent order, means that it won't receive execution unless the market rises or falls to a certain price. This certain price that's specified by the investor is the stop price

On margin

paid for with borrowed funds

Buy stop order

placed above the current market price and is used to limit a loss or protect a profit of a short sale. Ex. a customer sells short 100 shares at $40 and is bearish. However, he would like to protect his position against a rise in the price of ABC and places a buy stop order at $45. If the stock rises to the stop price of $45 or above, the order is activated and 100 shares will be bought immediately

Sell limit order

placed above the current market price of a security

Buy stop limit order

placed above the current market price of the security and is used to limit the loss or protect a profit on a short position. However, once activated, it becomes a buy limit order and, therefore, execution will only occur if the stock can be purchased at the limit price or lower

Buy limit order

placed below the current market price of a security

Sell stop order

placed below the current market price of the security and is used to limit a loss or protect a profit on a long stock position. Ex. you purchase 100 shares at $25 and want to limit any losses to 5 points, so put in this at $20. This means if the stock falls to $20 or below, the order is triggered and you sell 100 shares immediately

Sell stop limit order

placed below the current market price of the security and is used to limit the loss or protect a profit on a long position. However, once activated, it becomes a sell limit order and therefore execution will only occur if the stock can be sold at the limit price or higher

Types of transactions

purchase long sale short sale

Inside market

represents the highest bid and lowest ask (offer price) of any market maker in a given security

Stop-limit order

similar to a stop order in that if the market trades at or through the preset stop price, the order will be activated. However, once activated, this becomes a limit order and may be executed only at a specific price or better. Combination of both stop orders and limit orders, which means the customer may not receive execution on the order. Presents a risk/reward trade-off: risk is that since a specific limit price is set, the order may never receive execution. Reward is that if the order receives execution, the customer will receive the preset limit price or better

Long sale

the customer sells stock that he/she currently owns

Short sale

the investor sells shares that he/she does not own; therefore, the shares must be borrowed. As long as the shares are able to be borrowed, the short seller's broker dealer will execute the short sale. Since the borrowed shares will ultimately need to be returned to the lender, the short seller will need to buy back the stock at some point in the future. A profit for the short seller is realized if she is able to buy the shares back at a price that's less than the price at which they were originally sold. The strategy for a short seller is bearish (i..e she will profit if the price of the stock falls). On the other hand, if the price rises, the investor's loss could be significant since the stock would need to be purchased at a price that's higher than the price at which the shares were originally sold

Uncovered/naked call seller

the seller of a call does not own the shares and is at risk of being required to buy shares at an unknown market price in order to complete the delivery of the shares to the call buyer. May only be executed in a margin account

Covered call seller

the seller of a call option owns the underlying stock, can cover if assigned

Solicited

the trade was recommended by the RR

Limit orders

used when customers want to buy or sell securities at a specific price. May be executed only at the specified price or better. A buy limit order may only be executed at the limit price or lower, while a sell limit order may only be executed at the limit price or higher. Used for large orders in thinly or infrequently traded securities in which the spread is wide. Risk is that it may never be executed

Commissions

when a firm acts in a broker (agent) capacity, it earns this for its efforts. This is a separate dollar amount that must be noted on the client's trade confirmation. However, if a trade is not executed, this will not be earned

Dealers (principals)

when a firm buys securities for, or sells securities from, its own account (inventory), it is acting as this. If they always stand ready to buy or sell a specific stock, they are also referred to as a market maker. As both a buyer and a seller, they provide a two-sided quote (bid/offer). Charge markups or markdowns

Markup/markdown

when acting in a dealer capacity, a firm will adjust its prices for retail customers. In other words, the dealer will include one of these. They are calculated from a security's inside market. If a firm is buying shares = markdown, selling = markup