Chapter 1/2 Flashcards
What is an issuer?
A legal entity that sells securities in order to finance its operations. Issuers include, the U.S. Treasury, foreign governments, local governments, corporations, and banks.
Brokerage
A brokerage account allows an investor to deposit funds (stocks, bonds, options, cash, etc.) with a licensed brokerage firm and then buy, hold, and sell a wide variety of investment securities.
Debt vs equity
Debt: bonds are essentially loans provided by issuers to creditors/bondholers. The issuer is required to repay the principal balance of the bond at a future date and will typically make interest payments over the life of the loan.
Equity: Stocks. This is where the stockholders are owners of the business.
- Advantages/disadvantages of equity: Firms must dilute their ownership in order to sell shares. The advantage is that they do not owe anything.
- Advantages/disadvantages of bonds: There was no dilution but money will need to be paid back.
Broker
Any person that engages in the business of effecting agency transactions in securities for the account of others. Essentially, brokers match up buyers and sellers and earn a commission
Dealer
Any person that engages in the business of buying and selling securities for its own account
Investment Banking
The area that works directly with the issuers to arrange and structure their securities offerings. Investment bankers often underwrite securities.
Equity research
A department of a brokerage that studies markets and issuers in order to make equity recommendations.
Sales department
This department markets stocks or bonds or packaged products to retail investors and institutions
Registered representatives (RRs)/Investment adviser representatives (IARs)
People who work in the sales department
Trading department
A department that handles the execution of trades for both the firm’s clients and the firm’s own (proprietary) account.
Operations department
Ensures that all of the paperwork, funds, and securities transfers that are associated with a trade (or processing) are handled efficiently and according to specific industry standards.
Market maker
When a broker-dealer chooses to display quotes into a trading system to indicate its readiness to buy and/or sell securities at specific prices. Market makers sell securities from their own inventory. A market maker’s quote shows the bid price participants are willing to buy at and the ask/offer price that sellers are willing to sell at.
True or false: Many financial firms act as investment advisers (IAs), rather than functioning as broker-dealers?
True
Difference between investment adviser (IA) and broker dealer?
Broker dealers earn commissions, whereas investment advisors charge fees. The fees occur regardless of whether any trades occurred in thier clients’ accounts.
How to determine which regulator with whom the IA must register with?
- If the IA has AUM of less than $100 million, it must register with the state(s) in which it conducts business.
- If the IA has AUM between $100 and $110 million, it may register with either the SEC or the state(s).
- If the IA has AUM in excess of $110 million, it must register with the SEC.
Municipal advisor
A type of advisor that provides advice either to or on behalf of a municipal entity. The client is typically an issuer, not an investor.
Types of investors
- Retail investors: Investors who buy stocks/bonds directly from broker dealers.
- Accredited investors: certain investors who, by the nature of their income or assets, are viewed as more sophisticated and/or able to assume greater risk.
- Institutional investors: large entities that pool their money to purchase securities (ex: banks, asset mgmt, etc.)
- To be defined as institutional investor TA must be at least $50MM.
- To be defined an accredited investor, an individual must be worth $1MM, excluding their primary residence.
Qualified institutional buyer (QIB)
To be considered a QIB, an entity must satisfy 3 things:
1. Be one of these entities: insurance, registered investment company, small business development company, pension plans, bank trust funds, or Corporations, partnerships, business trusts, and certain non-profit organizations
2. The buyer must be purhcasing for its own account or of the account of another QIB
3. The buyer must own and invest at least $100MM of securities of issuers that are not affiliated with the buyer.
- QIBs are entities, NOT humans.
Primary vs secondary market
Primary market: The market where the newly issued security is sold. The primary market is regulated by the SEC.
Secondary market: The market where securities are traded second hand.
Listed security
Any equity securities that meet the standards for trading on a national exchange
Third market
Where exchange-listed securities are traded over-the-counter or away from traditional exchanges. Usually these are between broker-dealers and large institutions.
- This market has grown significantly in recent years
Fourth market
Direct institution-to-institution trading and doesn’t involve the public markets or exchanges. Most true fourth-market trades are internal crosses set up by broker-dealers that execute trades for institutional accounts.
Electronic communication networks (ECNs)
Exchanges that allow for both the quoting and trading of exchange-listed securities. Retail and institutional investors can use ECNs. The objective of an ECN is to provide an electronic system for bringing buyers and sellers together. These systems allow subscribers to disseminate information about orders, execute transactions both during the trading day and after-hours, and buy and sell anonymously.
Dark pools
A system that provides liquidity for large institutional investors and high-frequency traders, but it doesn’t disseminate quotes. The name is derived from the fact that the details of the quotes are concealed from the public. Allows for institutions to buy/sell stocks anonymously. Some dark pools provide order matching systems and may also allow participants to negotiate prices.
What does clearing a trade mean?
When the buyer and seller must agree on the terms of the transaction
Settlement
When the seller delivers the security to the buyer
Depository Trust & Clearing Corporation (DTCC)
A securities depository and a national clearinghouse for the settlement of transactions in equities, corporate, municipal, and U.S. government bonds, mortgage-backed securities, money-market instruments, and over-the-counter derivatives. The primary goal of the system is to eliminate physical securities in order to increase the speed and reduce the cost of clearing and settling trades.
- The DTCC is a non-profit, industry-owned corporation. Its owners include broker-dealers, investment banks, commercial banks, and mutual fund companies. The DTCC and its subsidiaries are regulated by the SEC and the depository is also a member of the U.S. Federal Reserve System.
National Securities Clearing Corporation (NSCC)
A subsidiary of the DSCC. This entity clears equity trades
Fixed income clearing corporation (FICC)
A subsidiary of the DSCC. This entity clears bond trades
Clearing firms vs introducing firms
Clearing firms: A step below DTCC on the hierarchy. Broker-dealers perform order execution, clearing, and settlement functions. Clearing firms interface with the DTCC directly for both their own transactions as well as those of any other broker-dealers that choose to clear through them.
Introducing firms: These firms contract with clearing firms to perform clearing services.
True or false: A clearing broker may provide introducing firms with back office and related recordkeeping functions on either a fully disclosed or omnibus basis?
True, the difference is the level of detail the clearing firm will have regarding the customer as well as which entity will be responsible for providing trade details to the customer.
Fully disclosed accounts vs omnibus accounts
Fully disclosed accounts: This means that information about each of the individual customers of the introducing firm will be transmitted to the clearing firm and the clients’ assets are held at the clearing firm. The clearing firm establishes separate accounts for each client and is responsible for all of the paperwork associated with the accounts, such as the delivery of confirmations and statements.
Omnibus accounts: In this case, since the clearing firm doesn’t have information on each individual customer, the recordkeeping responsibilities belong primarily to the introducing firm.
Hedge fund
An investment fund that uses sophisticated strategies in an attempt to generate returns that are higher than traditional stock or bond investments.
Prime brokerage
The prime brokerage relationship consist of a bundled package of services that’s offered to hedge funds, institutions, and high net worth individual clients. The clearing firm acts as a centralized location for holding all of the positions that were created by the various executing firms through which the client trades. In a prime-brokerage arrangement, the client chooses one firm as its prime broker to consolidate the bookkeeping process. Although the client may still use several broker-dealers for execution purposes, all of the trades are ultimately handled through its account at its prime broker.
Options
A type of derivative that tracks the value of an individual stock, an index, or foreign currency. Options contracts can be purchased either on one of the options exchanges or in the over-the-counter market.
- Listed are options that are traded on exchanges.
Standardization
When the terms of the option contracts are set and uniform.
True or false: The DTCC clears option trades?
False, the OCC does.
Not the Office of the Comptroller of the Currency
Options clearing corporation (OCC)
Listed options are issued and guaranteed by the Options Clearing Corporation much in the same way that the DTCC guarantees locked-in trades for its members. The OCC is regulated by the SEC. When customers buy or sell option contracts, their broker-dealers must settle the transactions with the OCC within one business day.
- The OCC issues, gaurentees, and clears options.
- The OCC only settles contracts with broker dealers, NOT with customers directly.
Custodian
Banks or other institutions that hold customers’ securities for safekeeping to prevent them from being lost or stolen
Registrar
An institution responsible for keeping records of bondholders and shareholders after an issuer offers securities to the public. The registrar also ensures the corporation doesn’t issue more shares than the number of authorized shares.
Transfer Agent
An entity who keeps records of who owns a publicly traded company’s stocks and bonds. They also ensure investors receive dividends/interest payments on time. These entities are also responsbile for handling lost or destroyed security certificates of ownership.
Securities trustees
For some types of investments, such as select bonds, loans, or trusts, a trustee is assigned to hold security interests that are created on trust for the benefit of various creditors. Some bond trustees also ensure that issuers abide by promises (covenants) that are found in a formalized agreement which is referred to as a trust indenture.
True or false: An entity that sells securities from its own inventory is a broker?
False, market maker
True or false: All shares that are held in street name are actually registered under the registrar’s name?
False, the broker-dealer’s name.