Trading Market Basics

A securities firm does a trade for a customer and charges a commission. In what capacity did the firm act? A. Agent B. Dealer C. Principal D. Market Maker

The best answer is A. A FINRA member firm can do securities transactions in one of two ways. It can act as a broker, routing the order to the best market, charging a commission for this service. This is called an agency trade, and the firm is acting as a middleman in the transaction. The other way to do the trade is to act as a dealer. Here, the firm maintains an inventory of the security, and acts as a principal, buying the security into inventory from the customer; or selling to the customer out of inventory. When acting as a principal, the firm earns a mark-up when selling to the customer out of inventory; or a mark-down when buying into inventory. Also note that the firm can only act in one capacity in a given transaction - either as a broker or as a dealer. Thus, it could not charge both a commission and a mark-up in the same transaction.

Quotes from all market centers in NYSE listed securities are found on (the): A. CQS (Consolidated Quotations Service) B. UQDF (UTP Quote Data Feed) C. ADF (Alternate Display Facility) D. Pink Sheets

The best answer is A. CQS (Consolidated Quotations Service) aggregates and displays quotes for all market makers in exchange listed issues - both NYSE and NYSE American (AMEX) listed. These market makers are exchange Specialists (DMMs) and Third Market Makers (OTC firms that make markets in exchange listed issues). The UQDF (UTP Quote Data Feed) aggregates and displays quotes for all market makers in NASDAQ issues. UTP stands for "Unlisted Trading Privileges." Not only do NASDAQ Market makers quote and trade NASDAQ stocks, but exchange Specialists/DMMs are now permitted to compete and trade NASDAQ stocks under a "UTP" plan. The ADF is where ECN quotes are found (Fourth Market). The Pink Sheets (Pink OTC Markets) give quotes for stocks that do not meet exchange listing standards - most of these are "penny stocks."

All of the following securities are traded in the secondary market EXCEPT: A. Mutual funds B. NYSE listed stocks C. NASDAQ listed stocks D. OTC stocks

The best answer is A. Open end funds (mutual funds) are redeemable with the sponsor - they do not trade. All stocks are traded in the secondary market, with much higher trading volumes for NYSE and NASDAQ listed issues; and much lower trading volumes for OTC issues quoted in the OTCBB or Pink Sheets.

An order for a New York Stock Exchange listed issue is routed by the member firm to an Electronic Communications Network (ECN) rather than to the exchange floor. This practice is permitted: A. if the price offered by the ECN is better B. only if the customer consents C. only if an attempt to fill the order on the NYSE fails D. only if the NYSE is closed

The best answer is A. SEC rules require that execution must occur at the "best market." If a stock is traded in multiple markets, then the order must be routed by the member firm to the market that is posting the best quote.

Which statement is TRUE? A. A securities dealer will buy stock at the bid price and sell stock at the ask price B. A securities dealer will sell stock at the bid price and buy stock at the ask price C. A securities dealer will buy stock and sell stock at the midpoint between the bid and ask price D. A securities dealer will buy and sell stock at the price of the last reported trade

The best answer is A. Securities dealers quote stocks with a bid and ask. The bid is the price at which the dealer is willing to buy from the customer (therefore, the customer is selling to the dealer at the bid). The ask is the price at which the dealer is willing to sell to the customer (therefore, the customer is buying from the dealer at the ask).

A securities dealer is quoting ABCD stock at 10.00 - 11.00 (15 x 20). This means that the dealer is willing to: A. buy 1,500 shares at $10 and sell 2,000 shares at $11 B. sell 1,500 shares at $10 and buy 2,000 shares at $11 C. buy 1,000 shares at $15 and sell 1,100 shares at $20 D. sell 1,000 shares at $15 and buy 1,100 shares at $20

The best answer is A. Securities dealers quote stocks with a bid and ask. The bid is the price at which the dealer is willing to buy from the customer (therefore, the customer is selling to the dealer at the bid). The ask is the price at which the dealer is willing to sell to the customer (therefore, the customer is buying from the dealer at the ask). Within the brackets is the "size" of the quote - how many shares the quote is good for. This dealer is willing to buy 1,500 shares at $10 and is willing to sell 2,000 shares at $11. The "size" is 15 x 20 - this translates into 1,500 shares bid at $10 and 2,000 shares offered at $11 by the dealer.

Stocks that are listed on the New York Stock Exchange can also be typically listed and traded on all of the following exchanges EXCEPT: A. American Stock Exchange B. Chicago (Midwest) Stock Exchange C. Boston Exchange D. Pacific Exchange

The best answer is A. Stocks that are listed on the NYSE are typically NOT listed on the AMEX (now renamed the NYSE American) or NASDAQ. Each one of these is a "national" stock exchange, trading companies where there is a "national interest" in trading those stocks. A dual listed stock is one which trades in more than one marketplace, and the typical example is a company that listed on a regional exchange when it was small, and then grew large enough to list on a national exchange. For example, a young New England company might have listed on the Boston exchange when it was still small; and then listed on the NYSE when it became large enough; and it kept its Boston exchange listing to maintain its New England "ties."

A dual listed stock is one which trades in two different: A. countries B. U.S. markets C. cities D. states

The best answer is B. A dual listed stock is one which trades in more than one marketplace - for example, a young West Coast company might have listed on the Pacific exchange when it was still small; and then listed on the NYSE when the company became large enough. Finally, note that most companies are only listed on 1 major market because each exchange charges listing fees, and corporations see no reason to pay multiple listing fees.

An "efficient" market is characterized by: I Narrow Spreads II Wide Spreads III Low Trading Volume IV High Trading Volume A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. An efficient market is one where there is a high trading volume, so that liquidity risk is minimized. As trading volume increases, dealer spreads will narrow, since the dealer doesn't have to make as much on each trade to be profitable.

Which statements are TRUE? I Trades of NYSE listed issues, regardless of the market venue where the trade took place, are reported via the Network A Tape II Trades of NYSE listed issues, regardless of the market venue where the trade took place, are reported via the Network C Tape III Trades of NASDAQ listed issues, regardless of the market venue where the trade took place, are reported via the Network A Tape IV Trades of NASDAQ listed issues, regardless of the market venue where the trade took place, are reported via the Network C Tape A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Reports of trades of NASDAQ issues are made through the Network C Tape, regardless of the market venue where the trade took place. The Network A Tape reports trades of NYSE-listed issues, regardless of the market venue where the trade took place. The Network B Tape reports trades of NYSE American (AMEX) and regional exchange-listed issues, regardless of the market venue where the trade took place.

The Second Market is a(n): A. auction market B. negotiated market C. unregulated market D. primary market

The best answer is B. The Second Market is trading of unlisted securities "over-the-counter." This is a negotiated market. For example, a stock quoted in the OTCBB is actually traded by picking up the phone, calling the market maker posting the quote, and negotiating a price.

The NYSE Specialist (DMM) and Floor Trader system is the model for trading used by which of the following markets? I NASDAQ II AMEX (NYSE American) III PHLX IV BATS A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. All of the regional stock exchanges, such as the Philadelphia Stock Exchanges (PHLX), as well as the American Stock Exchange (now renamed the NYSE American), model their trading after the NYSE Specialist/DMM and Floor Trader system. NASDAQ is an all electronic market, while BATS (Better Alternative Trading System) is an all electronic market that started as an ECN, but has grown so large that the SEC now recognizes it as an exchange. Note: The regional exchanges as independent entities are a dying breed. At the end of 2007, NASDAQ purchased the PHLX and the Boston stock exchanges. The NYSE has purchased the Pacific and American stock exchanges and has renamed the Pacific as the "ARCA" exchange and the American as the "NYSE American." These must still be known for the exam, since these are being run as separate subsidiaries of the major markets.

A dual listed stock is one which trades in: A. the second market B. the secondary market C. two different U.S. market venues D. the primary and secondary markets

The best answer is C. A dual listed stock is one which trades in more than one marketplace (market "venues") - for example, a young West Coast company might have listed on the Pacific exchange when it was still small; and then listed on the NYSE when the company became large enough. Finally, note that most companies are only listed on 1 major market because each exchange charges listing fees, and corporations see no reason to pay multiple listing fees.

Execution of a trade routed to an ECN is: I guaranteed since the ECN is a market maker in the security II not guaranteed since the ECN executes trades solely by matching customer orders III subject to the "best execution" rule IV not subject to the "best execution" rule A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. ECNs - Electronic Communications Networks - do not act as dealers - only as agents, earning a fee on each successful transaction. Thus, there is no assurance that an order placed on an ECN will be filled. All orders sent by broker-dealers to any public marketplace are subject to the "best execution rule" - that is, the broker-dealer can only direct the order to the market posting the best price at that moment. If a number of markets are posting the same "best" price, then the broker-dealer can choose any of those markets to get the order - and can use "payment for order flow" as a deciding factor in the order routing.

All of the following statements are true if a customer places an order for an NYSE listed issue EXCEPT the order: A. must be directed by the member firm to the NYSE trading floor for execution if the customer so requests B. can be directed by the member firm to any trading venue if the customer does not direct the order to a specific market C. can be matched internally by the member firm and is not required to be sent to a public trading venue D. can be directed by the member firm to a trading venue that "pays for order flow" as long as this is disclosed to the customer

The best answer is C. FINRA member firms cannot match orders internally and cannot "privatize" their trades. All trades must be effected in a public venue - whether it be on the NYSE floor; in the Third Market; or through an ECN. Member firms are permitted to accept payment for order flow, but this must be disclosed to customers. Also remember that any trade price must be the "best" one available at that moment in the public markets.

Retail member firms that route orders to market makers in return for compensation: I are engaging in a prohibited practice under SEC rules II permitted to do so, subject to best execution requirements III must disclose the practice on customer confirmations IV are not required to disclose the practice on customer confirmations A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. If a retail member firm chooses a market maker to execute its orders in return for compensation from that market maker, then the retail firm is earning so-called "payment for order flow." The SEC permits this practice, subject to the retail member firm always executing its trades at the best available price. And payments made for order flow must be disclosed on customer confirmations.

The "after hours" trading market for exchange listed and NASDAQ securities: I is a more liquid market than the regular hours trading session II is a less liquid market than the regular hours trading session III typically has wider dealer bid-ask spreads than regular trading sessions IV typically has narrower dealer bid-ask spreads than regular trading sessions A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The "after hours" trading sessions have much lower investor participation, so trading volumes are very small. Because of the lack of order flow, the market is less liquid; and as a result, dealers who make the market demand wider bid-ask spreads.

The individuals who make a secondary market in corporate bonds include which of the following? I Market Makers II Underwriters III Traders IV Dealers A. I and II B. II and IV C. I, III, IV D. I, II, III, IV

The best answer is C. The secondary market is the trading of issues outstanding in the market. The individuals making the secondary market are the market makers (also known as dealers) and traders. Underwriters take new issues public in the primary market (new issues), not the secondary (trading) market. Once these issues are placed by the underwriter, they begin to trade in the secondary market.

The First Market includes trading in: A. unlisted issues B. new issues C. NYSE issues D. OTC issues

The best answer is C. The First Market is trading of listed stocks on an organized stock exchange - like the NYSE, AMEX (now renamed the "NYSE American") or NASDAQ exchanges. Exchanges have listing standards for the companies that trade there and accessible order books, where orders can be posted and traded against. Any companies that do not meet exchange listing standards ("unlisted securities") are quoted in either the OTCBB (Over The Counter Bulletin Board) or the Pink OTC Markets. These constitute the Second Market. Both the OTCBB and Pink OTC Markets are classified by the SEC as "quotations vendors" - they are not exchanges. To trade an OTCBB or Pink OTC Markets stock, the trade must be negotiated, usually over the phone. New issues are sold for the first time in the Primary Market.

The Primary Market is the: A. trading of exchange listed securities on that exchange floor B. trading of securities that are not exchange listed in the over-the-counter market C. trading of exchange listed securities in the over-the-counter market D. sale of new issues for the first time

The best answer is D. The Primary Market is the sale of new issues for the first time; no trading takes place in the Primary Market. The trading of exchange listed securities on that exchange floor is the definition of the First Market. The trading of securities that are not exchange listed in the over-the-counter market is the definition of the Second Market. The trading of exchange listed securities in the over-the-counter market is the definition of the Third Market.

Typically, a dual listed stock is one that trades in: A. the First and Third Markets B. the Second and Third Markets C. the Third and Fourth Markets D. multiple First Markets

The best answer is D. A dual listed stock is one that is listed on more than one exchange, and any exchange is a First Market. A typical dual listed stock is listed on both the NYSE and a smaller regional exchange. There is no such thing as a dual listing between an exchange and the Third or Fourth Markets. Both the Third and Fourth Markets do not have "listings." Finally, note that most companies are only listed on 1 major market because each exchange charges listing fees, and corporations see no reason to pay multiple listing fees.

The Third Market trades: A. listed and unlisted stocks between institutions without the use of a broker B. listed securities on the trading floors of regional exchanges C. unlisted securities over-the-counter D. listed securities over-the-counter

The best answer is D. The "Third Market" is over-the-counter trading of exchange listed securities. It can be viewed as a competitor for the exchanges as a place to execute trades of exchange listed stocks. Third Market Makers are OTC firms such as Jefferies and Co. and Weeden and Co. that stay open 24 hours a day and capture much of their trading volume in NYSE-listed issues when the NYSE is closed.

The trading of listed securities over-the-counter occurs in the: A. Primary Market B. First Market C. Second Market D. Third Market

The best answer is D. The "Third Market" is over-the-counter trading of exchange listed securities. Third Market Makers are OTC firms such as Jefferies and Co. and Weeden and Co. that stay open 24 hours a day and capture much of their trading volume in NYSE-listed issues when the NYSE is closed.

Which of the following are part of the Second Market? I NYSE II Pink OTC Market III NASDAQ IV OTCBB A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. The First Market is trading of listed stocks on that exchange. The major stock exchanges with trading floors are the NYSE and NYSE American (AMEX). In late 2006, NASDAQ was recognized by the SEC as the first completely electronic exchange with no physical trading floor. Exchanges have listing standards for the companies that trade there and accessible order books, where orders can be posted and traded against. Any companies that do not meet exchange listing standards are quoted in either the OTCBB (Over-The-Counter Bulletin Board) or the Pink OTC Markets. These constitute the Second Market. Both the OTCBB and Pink OTC Markets are classified by the SEC as "quotations vendors" - they are not exchanges. To trade an OTCBB or Pink OTC Markets stock, the trade must be negotiated, usually over the phone.

A trade takes place directly between a bank and an insurance company without the use of a broker. This trade took place in the: A. First Market B. Second Market C. Third Market D. Fourth Market

The best answer is D. The Fourth Market is direct trading of securities between institutions on ECNs (Electronic Communications Networks) such as Instinet or Archipelago. The systems bypass brokerage firms, and therefore brokerage commissions. Instead, the ECN charges a small matching fee.

Futures contracts trade on the: A. NYSE B. AMEX (NYSE American) C. CBOE D. CBOT

The best answer is D. The NYSE trades stocks. The AMEX trades stocks and stock options. The AMEX is a wholly owned subsidiary of the NYSE, and it has renamed its equities market "NYSE American," while its options market is still called the AMEX. The CBOE trades stock options and index options. The CBOT - Chicago Board of Trade - is not a securities exchange. Rather, it is a futures market.

The Secondary Market is divided into the: I First Market II Second Market III Third Market IV Fourth Market A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. The Secondary Market is categorized into 4 sub-markets: the First; Second; Third; and Fourth Markets. The First Market is trading of exchange listed securities on that exchange. The Second Market is trading of securities that are not exchange listed in the over the counter market. The Third Market is trading of exchange listed securities in the over the counter market. The Fourth Market is trading of securities directly between institutions in the over the counter market via ECNs (Electronic Communications Networks) such as Instinet.