Trading Markets

Many years ago, a customer bought 1,000 shares of XYZ stock at $40 per share. The company spins off a subsidiary to its shareholders, and the customer gets 100 shares of PDQ stock as a result. On the first day of trading after the spin off, PDQ closes at $20, while XYZ closes at $50. The customer will have a: A. $40,000 cost basis in XYZ and a $2,000 cost basis in PDQ B. $38,000 cost basis in XYZ and a $2,000 cost basis in PDQ C. $50,000 cost basis in XYZ and a $2,000 cost basis in PDQ D. $48,000 cost basis in XYZ and a $2,000 cost basis in PDQ

B. $38,000 cost basis in XYZ and a $2000 cost basis in PDQ The aggregate cost basis does not change in a spin-off. The original cost basis in XYZ stock is $40,000. After the spin off, the customer gets 100 shares of PDQ, with a $20 per share value = $2,000. This is the PDQ cost basis, and it comes out of the XYZ cost basis. $40,000 XYZ cost basis - $2,000 PDQ cost basis = $38,000 adjusted XYZ cost basis.

Regular way trades of U.S. Government securities settle: I next business day II in 2 business days III in Clearing House funds IV in Federal Funds A. I and III B. I and IV C. II and III D. II and IV

B. I and IV

For municipal transactions effected on a yield basis, how are these bonds generally priced? I Discount bonds are priced to maturity date II Discount bonds are priced to the near-term call date III Premium bonds are priced to maturity date IV Premium bonds are priced to the near-term call date A. I and III B. I and IV C. II and III D. II and IV

B. I and IV For transactions in callable issues effected on a yield basis, discount bonds are priced to maturity while premium bonds are priced to the near term call date. Thus, the customer is always given a dollar price that ensures he will, at a minimum, get the promised yield.

An investor holds shares of a stock that declares a 10% stock dividend. Which of the following statements are TRUE regarding the stock position after the dividend is paid? I The cost basis per share is adjusted II The cost basis per share remains the same III The distribution is taxable IV The distribution is not taxable A. I and III B. I and IV C. II and III D. II and IV

B. I and IV Under IRS rules, stock dividends are not taxable at the time of receipt. The stock dividend results in the cost basis per share being reduced, with the number of shares held increased proportionately. In aggregate, the customer's cost basis remains the same.

Over the course of 10 years, a customer has accumulated a position of 5,000 shares of ABC stock, purchased in 100 and 200 share lots. The stock has appreciated greatly in the last year and the customer places an order to sell 1,000 shares. The customer would minimize any capital gains tax liability by using which method for determining the cost basis of the shares sold? A. "Specific identification" allowing the customer to select the shares with the highest cost basis B. LIFO (Last-In/First Out) accounting, requiring the customer to use the cost basis of the last shares acquired C. FIFO (First-In/First Out) accounting, requiring the customer to use the cost basis of the first shares acquired D. The average per share cost of all 5,000 ABC shares acquired by the customer

A. "Specific identification" allowing the customer to select the shares with the highest cost basis The Tax Code allows the use of "specific identification" when selling securities. Thus, a customer with a large holding of appreciated stock can "choose" the more expensive shares as the ones that were sold, reducing any potential capital gain. If specific identification is not used, then the IRS requires FIFO (First In / First Out) accounting.

If a customer does not give a broker his or her instructions, cost basis reporting on Form 1099-B for a stock holding where there have been multiple purchases at different times is done on a: A. FIFO basis B. LIFO basis C. Specific identification basis D. Random selection basis

A. FIFO basis Cost basis reporting to the IRS is required on Form 1099-B. The Form includes the cost basis of the security, the sale proceeds, and whether the holding period is short term or long term. If there are multiple purchases of the stock position, absent customer instructions, FIFO is used to report cost basis. If the customer gives instructions to the broker, then specific identification can be used - which is beneficial if higher cost shares are selected to either reduce capital gains or increase reported capital losses.

Trades of options settle "regular way": I next business day II in 2 business days III in Clearing House funds IV in Federal Funds A. I and III B. I and IV C. II and III D. II and IV

A. I and III Regular way trades of options settle next business day in Clearing House funds. Only trades of government and agency securities settle in Fed Funds.

A customer has purchased shares of stock over an extended period of time at varying prices. The customer now sells some of the shares. Which statements are TRUE regarding the tax treatment of the sale? I The Tax Code allows specific identification of the shares being sold II The Tax Code prohibits the specific identification of shares being sold III FIFO accounting must be used to establish the cost basis of the shares sold, if no other tax election is available IV LIFO accounting must be used to establish the cost basis of the shares sold, if no other tax election is available A. I and III B. I and IV C. II and III D. II and IV

A. I and III The IRS allows stockholders to select which shares they are selling when computing capital gains tax liability. Thus, the taxpayer can choose the higher cost shares to reduce any potential capital gain upon sale. If specific identification is not used, the shareholder must use FIFO - first in, first out - accounting.

Which of the following call provisions must be considered when determining the purchase price of a municipal bond trade effected on a yield basis? I Optional Calls II Extraordinary Optional Calls III Mandatory Calls IV Extraordinary Mandatory Calls A. I only B. I and III C. II and IV D. I, II, III, IV

A. I only When a municipal dealer gives a basis quote, he or she is promising the purchaser a certain yield on the bond. MSRB rules require that when the actual dollar price is determined, that the dollar price be computed to the lowest dollar amount of yield to call or yield to maturity. *The only calls that are considered are OPTIONAL CALLS, meaning the issuer has the option of calling in the ENTIRE issue at preset dates and prices, as set forth in the bond contract.* Mandatory calls are not considered - an example of a mandatory call is a "sinking fund" call. In such a call, the issuer is obligated to deposit monies annually to a sinking fund, and then use the funds to call in bonds on a RANDOM pick method at specified dates. It is the luck of the draw as to whether a given bond is called or not. Since there is no reasonable certainty of a specific bond being called, this type of call is not considered when pricing municipal bonds. Extraordinary calls (such as catastrophe calls, or calls of bonds backed by mortgages due to mortgage prepayments) are not considered, again because of the lack of any certainty as to their actually happening.

The trading of securities on regional stock exchanges is most similar to trading, as it takes place, on the: A. NYSE B. CBOE C. NASDAQ D. MSRB

A. NYSE

Which of the following is an order to sell that is placed below the current market? A. Sell 100 ABC @ 50 Stop B. Sell 100 ABC @ 50 Day C. Sell 100 ABC @ 50 GTC D. Sell 100 ABC @ 50 AON

A. Sell 100 ABC @ 50 Stop There is only one order to sell which is placed below the current market - a sell stop order. Sell Stops are placed below the current market and are elected at or below the stop price and then executed at the next available price (either at, above, or below the stop price of $50). The other choices are all sell limit orders that are placed higher than the current market. They are qualified in other ways - one is a day order; one is a good-til-canceled (GTC) order; and one is an all or none (AON) order.

ECNs trade: A. stocks B. stock options C. bonds D. mutual funds

A. stocks ECNs - Electronic Communications Networks - only accept orders for actively traded securities - that is, NYSE listed and NASDAQ stocks. Essentially they are electronic matching services, matching customer buy and sell orders on an agency basis only for a very low fee (often as low as $1 per trade). Stock options are not traded through ECNs since the ECNs are not members of the Options Clearing Corporation - thus they do not have the capability of reporting trades to the OCC for recordkeeping and margin purposes. Mutual funds do not trade - rather they are redeemable securities. Most bonds are traded through dealers in the OTC market.

All of the following information must be on an order ticket before it can be entered EXCEPT: A. execution price if the order is not a market order B. amount of accrued interest to be paid C. size of the transaction D. customer account name and/or number

B. amount of accrued interest to be paid The amount of accrued interest is calculated after a bond trade is executed - it is not on the order ticket that is used to enter the order. The ticket must include the size of the trade, desired execution price, and customer identification.

An order ticket to sell 100 shares of ABC short means that the seller will: A. deliver shares that are owned on settlement date B. deliver shares that are borrowed on settlement date C. not deliver shares on settlement date, but will deliver a due bill instead D. not deliver shares on settlement date, but will deliver the shares on a future date

B. deliver shares that are borrowed on settlement date A short sale is a sale of borrowed shares. The customer is speculating that the price of the security will drop, and borrows the shares from a broker to sell. These borrowed shares are delivered to the buyer on settlement date. The short seller intends to buy back the stock at a later date (hopefully at a lower price) and replace the borrowed (short) position.

An order to sell 100 shares of ABC at 50 GTC on the Specialist's book (DMM) is a: A. market order B. limit order C. stop order D. stop limit order

B. limit order A limit order specifies an execution price ("the limit"). An order to sell at 50 is a limit order. Market orders do not specify a price. Stop orders must state "Stop" with a price.

A customer places an order to buy bonds. The order reads "Buy 5M ABC 9s M '35 @ 90 GTC." The customer has entered a: A. stop order to buy at 90 B. limit order to buy at 90 C. market order to buy D. stop limit order to buy

B. limit order to buy at 90 Since a price is specified with no other qualifications, this is a limit order to buy $5,000 face amount ("5M") of 9% bonds maturing in 2035. The customer wants to pay 90% of par for the bonds or less. Open buy limit orders are executed if the market drops.

A customer places an order to sell bonds. The order reads "Sell 5M ABC 9s M '35 @ 90 GTC." The customer has entered a: A. stop order to sell at 90 B. limit order to sell at 90 C. market order to sell D. stop limit order to sell

B. limit order to sell at 90 Since a price is specified with no other qualifications, this is a limit order to sell $5,000 face amount ("5M") of 9% bonds maturing in 2035. Since a price is specified with no other qualifications, this is a limit order to sell. The customer wants to sell for 90% of par or more. Open sell limit orders are executed if the market rises.

In January, 20XX a customer buys 100 shares of ABC stock at $30 per share and pays a $1 commission per share. The customer receives $1 in cash dividends during the year. The customer's cost basis in the stock is: A. $29 per share B. $30 per share C. $31 per share D. $32 per share

C. $31 per share When the stock is purchased, any commission paid is not deductible - it is part of the cost basis of the shares. Thus, the cost basis for tax purposes is $30 + $1 commission = $31 per share. The $1 dividend received is included in taxable income for this year, and is not part of the stock's cost basis.

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

C. CQS (Consolidated Quotations Service) 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."

ABC corporation has set the record date for a cash dividend at Tuesday, July 23rd. The last day to buy the stock before it goes ex dividend is: A. July 17th B. July 18th C. July 19th D. July 22nd

C. July 19th

Which of the following can result in the creation of a short position? I Buying a stock on one exchange and simultaneously selling it on another exchange II Selling stock for a customer that is owned by that customer III Selling stock for a customer that is not owned by that customer IV Selling stock for the firm's account that is not owned by the firm A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

C. I, III, IV Short sales are sales of borrowed shares, so Choices III and IV are clearly short sales. Choice II is a long sale - selling stock that is owned. Choice I is an arbitrage transaction, where stock is bought on one exchange and simultaneously sold short on another exchange to lock in a price difference. The long position is delivered later to replace the borrowed shares.

Which of the following securities are actively traded in the secondary market? I Open end funds II Closed end funds III Real estate investment trusts IV Direct participation programs A. I and II B. III and IV C. II and III D. I, II, III, IV

C. II and III Closed end funds and REITs are listed on exchanges and are traded like all other stocks. Open end funds (mutual funds) are redeemable with the sponsor - they do not trade. Direct participation programs (limited partnerships) also do not trade - the investor is in the program for the life of the partnership and is only permitted to sell if the general partner in the venture approves.

A customer buys a NASDAQ stock in a principal transaction at $79 plus a $1 mark-up. Which statements are TRUE? I The cost basis for tax purposes is $79 per share II The cost basis for tax purposes is $80 per share III The trade will be reported to the tape at $79 per share IV The trade will be reported to the tape at $80 per share A. I and III B. I and IV C. II and III D. II and IV

C. II and III For tax purposes, any commissions or mark-ups charged to buy stock are considered to be part of the cost basis (therefore, they are not deductible). The cost basis is $79 plus $1 mark-up = $80 per share. The trade is reported to the tape exclusive of commissions or mark-ups, which are added well after the trade occurs. Remember, all trades are reported within 10 seconds, and the trade is reported at $79 per share.

The orders that are higher in price than the current market are: I Open Buy Limits II Open Buy Stops III Open Sell Limits IV Open Sell Stops A. I and III B. I and IV C. II and III D. II and IV

C. II and III Sell limits and buy stops are the orders that are placed above the current market and are elected as the market rises. Remember OSLOBS - Open Sell Limits and Open Buy Stops as the orders placed above the current market.

The "after hours" 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

C. II and III After hours trading is characterized by much lower trading volumes than during the regular trading day and, correspondingly, dealer bid-ask spreads are much wider.

Which of the following dates may be needed to compute the total dollar price of a municipal bond traded on a yield basis in the secondary market? I Dated date II Maturity date III Call date IV Put date A. I only B. II only C. II and III only D. I, II, III, IV

C. II and III only When pricing a municipal bond traded in the secondary market on a yield basis, the MSRB requires that the dollar price be computed on a "worst case" basis. For premium bonds, having the bond called early (losing the premium faster) is worst; so premium bonds must be priced to the nearest "in whole" call date. For discount bonds, having the bond last until the maturity date is worst, earning the discount slower. Thus, these dates are employed when pricing municipal bonds quoted on a yield basis. Put options have no effect on bond pricing, because exercise is at the option of the bondholder; not the issuer. The dated date has no meaning for pricing a bond trading in the secondary market. It is simply the legal date of issuance of the bond, and is the date from which interest started accruing on the issue.

Under IRS rules, if a customer selling shares of stock wishes to use specific identification instead of FIFO for cost basis reporting, the broker-dealer effecting the trade must be notified of this no later than: A. Purchase Date B. Sale Date C. Settlement Date D. Year-End Date

C. Settlement Date If a customer says nothing at the time of a stock sale, IRS rules requires that FIFO be used to determine which shares are sold. If the customer wishes to use specific identification instead, this must be chosen by the customer no later than settlement date.

A broker-dealer receives fully paid stock certificates from a customer that are to be deposited to the customer's margin account. Upon inspection, the cashier of the firm finds that some of the certificates are mutilated and the identification numbers cannot be discerned. The proper procedure is to: A. reject all the certificates and return them to the customer B. reject the mutilated certificates and return them with a "due bill" to the customer C. hold the mutilated certificates and request a validation letter from the issuer or transfer agent before crediting the account D. accept all the certificates and credit them to the customer's account

C. hold the mutilated certificates and request a validation letter from the issuer or transfer agent before crediting the account The proper procedure when receiving mutilated certificates from a customer is to validate the certificates with the issuer or transfer agent. Once they are validated, they can be deposited to an account for the customer.

The Third Market trades: A. listed securities on an exchange B. unlisted securities on an exchange C. listed securities over-the-counter D. securities of companies based in Third World countries

C. listed securities OTC The Third Market is OTC trading of exchange listed securities. Trading of listed securities on an exchange is the First Market. There is no formal name for trading of unlisted securities on an exchange floor, such as trading of OTCBB issues by exchange Specialists (DMMs) under a UTP (Unlisted Trading Privilege) plan - mainly because the exchanges don't bother to trade these issues (yet).

A customer places an order to sell 100 ABC at 12 Stop Limit, when ABC stock is trading at $13. The company is restructuring and has announced a special dividend of $2.85 to be paid to shareholders of record. On the ex date, the order will be: A. canceled B. reduced to $9.00 C. reduced to $9.15 D. executed at $12.00

C. reduced to $9.15 On ex dividend date, all open orders placed lower than the current market are reduced for cash dividends (except for orders placed DNR - Do Not Reduce). The intent is to make sure that the order does not become executable due to the fact that the stock's opening price is reduced by the dividend amount. The order was originally placed at $12. The adjusted order price is $12 - $2.85 reduction = $9.15 adjusted order price.

A customer places an order to "Buy 100 ABC @ 90 Stop." The customer wishes to buy the stock at: A. $90 per share B. the market price, if the market falls to $90 per share or lower C. the market price, if the market rises to $90 per share or higher D. a price that is no higher than $90 per share

C. the market price, if the market rises to $90 per share or higher This order is a Buy Stop order, which is placed above the current market value. If the market price rises to $90, the order is elected and becomes a market order to buy. Once elected, the order is executed at the next available price as a market order. The order is executed, but the specific execution price is unknown.

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

C. two different U.S. market venues 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.

If a municipal bond, callable at par, is quoted on a yield basis that is lower than the nominal yield, the price of the bond to a customer would be calculated based on: A. nominal yield B. current yield C. yield to call D. yield to maturity

C. yield to call If a bond is purchased at a premium, its yield to call will be the lowest effective yield. Under MSRB rules, bonds are priced on a worst case basis, meaning, in this case where the premium is lost in the shortest time period. This premium will be lost in the shortest period of time if the bonds are called early. Thus, under MSRB rules, premium bonds must be priced to the near term call date. Then, the customer gets, at a minimum, the yield promised. If the bonds aren't called, the yield actually improves on the bonds.

A customer has purchased 1,000 shares of ABC stock at $44 per share, paying a commission of $1.00 per share for the transaction. ABC stock declares a 20% stock dividend. When the dividend is paid, the tax status of the investment is: A. 1,000 shares held at a cost basis of $44 per share B. 1,000 shares held at a cost basis of $45 per share C. 1,200 shares held at a cost basis of $36.66 per share D. 1,200 shares held at a cost basis of $37.50 per share

D. 1,200 shares held at a cost basis of $37.50 per share The payment of a stock dividend increases the number of shares held by the investor and the cost basis must be reduced accordingly, since each share is theoretically worth less after the stock dividend is paid. The customer will have 1,000 shares x 1.20 = 1,200 shares after the dividend. Each share originally had a cost basis of $45 ($44 price plus $1 commission). After the dividend is paid, the cost basis is adjusted to $45/1.20 = $37.50. or... cost basis x 1000 shares (45x1000=45,000) 1000 shares x 1.20(stock div)= 1200 45000/1200= $37.50

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

D. CBOT 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.

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

D. Fourth Market 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.

Which of the following can result in the establishment of a short position? I Arbitrage transaction II Sale of a security "against the box" III Position trades of borrowed shares A. I only B. I and III C. II and III D. I, II, III

D. I, II, III Short positions are established in arbitrage transactions (the simultaneous purchase and short sale of a security in two different markets to lock in a temporary price difference). A short position is taken when a security is sold "against the box" - meaning that the long position is being held and an equivalent number of shares are being borrowed and sold to lock in a profit. Finally, position trades (position trading is trading for the firm account, using the firm's "positions") of borrowed shares are short sales.

In a falling market, which orders will be executed? I Open Buy Stops II Open Buy Limits III Open Sell Stops IV Open Sell Limits A. I and II B. III and IV C. I and IV D. II and III

D. II and III The orders that are executed if the market drops are "OBLOSS" - Open Buy Limits and Open Sell Stops. The orders that are executed in a rising market are "OSLOBS" - Open Sell Limits and Open Buy Stops.

Retail member firms that route orders to market makers in return for compensation earn: A. mark-ups B. mark-downs C. commissions D. payments for order flow

D. payments for order flow 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.

A broker-dealer holds a limit order to buy 100 shares of ABC stock at $20.00 for a customer. Which of the following trades are acceptable? I The purchase of 100 shares of ABC for the firm's trading account at $19.50 prior to executing the customer's order II The purchase of 100 shares of ABC for the firm's trading account at $20.50 prior to executing the customer's order III The long sale of 100 shares of ABC out of the firm's trading account to the customer at $20.00 IV The short sale of 100 shares of ABC out of the firm's trading account to the customer at $20.00 A. I only B. I and II only C. III and IV only D. II, III, IV

D. II, III, IV If a dealer holds a customer order, he or she cannot execute an order for the firm account that competes with that order - unless the customer order is executed first. Otherwise, the firm is "trading ahead" of the customer, which is prohibited. The customer has placed an order to buy 100 shares of ABC stock at $20. It is OK for the firm to buy the stock for its own account at $20.50 prior to executing the customer order, since the customer's limit price has not been met. However, the firm cannot buy for its own account at $19.50 until the customer order has been executed, since $19.50 is within the customer's limit. It is perfectly acceptable for the firm to sell the customer the stock at $20 out of its inventory account. It makes no difference whether the firm sells this stock long to the customer or if it sells the stock short to the customer. In trading accounts, firms routinely maintain both long and short positions

A customer places an order to sell 100 shares of ABC stock that he cannot deliver by settlement date. The order ticket should be marked: A. Sell - MKT B. Sell - GTC C. Sell - Long D. Sell - Short

D. Sell - Short A long sale is the sale of shares which the customer owns and will deliver on settlement date. A short sale is the sale of shares which the customer does not own. Therefore, in order to effect delivery on settlement date, the short seller must borrow the shares. In essence, a short seller is selling borrowed shares.

A member firm may use a third party to execute over-the-counter agency transactions for customer orders: A. under no circumstances B. if the resultant price is reasonably related to the inside market at that time C. if the resultant price is equal to the best available market at the time D. if the resultant price is better than the best available market at the time

D. if the resultant price is better than the best available market at the time As a general rule, interpositioning a third firm between the customer and the market maker is prohibited unless it can be demonstrated that the use of the "middleman" firm will result in a better execution for the customer.