Chapter 2

Question 1

exchanges

Answer 1

membership associations designed to facilitate trading among members, whether for their own accounts or for those of their customers.

Question 2

Over the counter Market

Answer 2

A decentralized market of securities not listed on an exchange where market participants trade over the telephone, facsimile or electronic network instead of a physical trading floor. There is no central exchange or meeting place

Question 3

New York Stock Exchange (NYSE)

Answer 3

biggest and most important of these exchanges. Known as the “Big Board”, the NYSE is located at 11 Wall Street in New York City and handles roughly three-fourths of all exchange transactions.

Question 4

American Stock Exchange

Answer 4

also known as the AMEX. The American Stock Exchange handles about 1/5 of the daily total of listed securities trades in the United States. AMEX stocks cannot be listed on the NYSE, while stocks from the regional exchanges can list on the NYSE.

Question 5

five primary regional exchanges

Answer 5

Boston Stock Exchange 
Chicago Stock Exchange 
Cincinnati Stock Exchange 
Pacific Stock Exchange 
Philadelphia Stock Exchange

Question 6

Specialist

Answer 6

The specialist holds an inventory of the stock, posts the bid and ask prices, manages limit orders and executes trades. Specialists are also responsible for managing large movements by trading out of their own inventory. If there is a large shift in demand on the buy or sell side, the specialist will step in and sell out of their inventory to meet the demand until the gap has been narrowed.

Question 7

Principal

Answer 7

1. The amount borrowed or the amount still owed on a loan, separate from interest.
2. The original amount invested, separate from earnings.
3. The face value of a bond.
4. The owner of a private company.
5. The main party to a transaction, acting as either a buyer or seller for his/her own account and risk.

Question 8

Agent

Answer 8

1. An individual or firm that places securities transactions for clients.
2. A person licensed by a state to sell insurance.
3. A securities salesperson who represents a broker-dealer or issuer when selling or trying to sell securities to the investing public.

Question 9

floor brokers: commission brokers

Answer 9

Commission brokers work for a particular member firm.

Question 10

floor brokers: two-dollar brokers.

Answer 10

Two-dollar brokers are independent brokers who execute orders for firms that do not have their own full-time commission brokers

Question 11

Secondary Market

Answer 11

The market in which securities are bought and sold is also known as the secondary market.

Question 12

market makers

Answer 12

Market makers are OTC dealers who buy and sell a minimum number of shares of a specific security at a quoted price.
The market maker acts more like a depository and distribution source for securities, absorbing excess stock when demand is low and providing the stock when demand is high. As a result, he or she bears the burden of risk, but also buys and sells for his or her own profit.

Question 13

spread

Answer 13

which is the difference between the bid price at which the market maker is willing to buy a security and the ask price at which he or she will sell the security.

Question 14

Securities trading on the Nasdaq must meet minimum listing requirements.
(2)

Answer 14

Nasdaq National Market securities and

Nasdaq Small Cap securities

Question 15

Stock Quotation Service Levels

Level 1

Answer 15

It displays the inside market only - that is, the best (highest) bids and the best (lowest) asks for securities in the system. Level I prices are not guaranteed, as the market fluctuates too rapidly for a firm quote.

Question 16

Stock Quotation Service Levels

Level 2

Answer 16

is available to FINRA approved subscribers only. It provides the current quote and quote size available from each market maker in a security. A market maker must guarantee a firm quote for at least 100 shares in a security in order to list a quote on the system.

Question 17

Stock Quotation Service Levels 3

Answer 17

provides subscribers with all of the services of Levels I and II. In addition, Level III allows market makers to update, change or delete their quotes and size of quotes on any security in which they make a market. Level III is the only level that allows quote inputs.

Question 18

broker-dealer

Answer 18

is a person or firm that is in the business of buying and selling securities.

Question 19

Agent/Broker

Answer 19

The firm will buy or sell a security on the client’s behalf and charge a commission for the service. In other words, the firm acts as a matchmaker, essentially never owning the security but, instead, finding a suitable buyer or seller on the OTC market or executing the transaction for the customer on one of the exchanges

Question 20

Principal/Dealer

Answer 20

In the second role, the firm acts as principal, or dealer, and buys or sells the security for itself, assuming actual ownership and, therefore, taking on more risk. The firm might sell the security to a customer from its own inventory or it may buy a security for its proprietary account. The firm’s profit comes from the commissions earned in the agent’s role

Question 21

initial public offerings, or IPOs.

Answer 21

New issues are offered in the primary market and sold to the public for the first time

Question 22

underwriting agreements/ First Comitment

Answer 22

most commonly used type of underwriting contract. The underwriter agrees to buy securities from the issuing corporation and pay the proceeds to the company. Any losses that occur due to unsold shares are prorated amongst the participating underwriting firms according to their proportional participation

Question 23

underwriting agreements/ Best Effort

Answer 23

Best effortsunderwriting allows the firm (or underwriting syndicate) to act as agent for the issuing corporation and limits the responsibility of that firm to the shares it is able to sell. All unsold shares are absorbed by the issuer.

Question 24

Underwriting agreements/All or None

Answer 24

All or none underwriting allows the issuing corporation to contract for the sale of all shares. If any shares remain at the end of the underwriting process, the underwriting is cancelled

Question 25

Underwriting agreements/Standby

Answer 25

Standbyunderwriting allows an underwriting firm (or syndicate) to wait in the wings in an additional offering for any unused pre-emptive rights that are not executed by the company’s current shareholders.

Question 26

trade date

Answer 26

for the purchase or sale of a security is the date on which the transaction is executed

Question 27

settlement date

Answer 27

is the date on which the transaction must be completed, or the date on which the buyer pays for the securities and the seller delivers them

Question 28

Regular-way settlement

Answer 28

for corporate stocks and bonds and municipal securities is three days after the trade date (T+3). For Treasury securities and options, settlement is T+1, or one day after the transaction. Cash transactions settle on the same day as the trade date.

Question 29

Ex-dividend

Answer 29

When a stock trades without its next dividend payment,

the ex-dividend date will always be two days prior to the stock’s record date.

Question 30

Record Date

Answer 30

specify the date by which an investor must own the stock and be registered on the company’s records as a shareholder in order to receive the dividend.

Question 31

Payment Date

Answer 31

The date the dividend is actually paid out to the shareholders

Question 32

Market Value

Answer 32

The current bid and ask prices for a security

Question 33

Bid

Answer 33

The price a market maker will pay for a security; it’s the price an investor would receive if he or she sold the security.

Question 34

Asked or Offering

Answer 34

This is the price an investor would pay when buying the security

Question 35

Net Asset Value (NAV

Answer 35

Refers to pricing of a mutual fund. It equals the total value of the fund’s portfolio less liabilities and is calculated daily.

Question 36

Par

Answer 36

Price at which the security was originally issued - used most often when referring to bond prices.

Question 37

Nominal Yield Bonds

Answer 37

simply the yield stated on the bond’s coupon. If the coupon is paying 5%, then the bondholder receives 5%.

Question 38

Current Yield-Bonds

Answer 38

This calculation takes into consideration the bond market price fluctuations and represents the present yield that a bond buyer would receive upon purchasing a bond at a given price. As mentioned earlier, bond market prices move up and down with investor sentiment and interest rate changes. If the bond is selling for a discount, then the current yield will be greater than the coupon rate. For instance, a 6% bond selling at par has a current yield that is equivalent to its nominal yield, or 6%. A bond that is selling for less than par, or at a discount, has a current yield that is higher than the nominal yield.
The current yield formula is as follows:
Current Yield =Annual Interest Payment
Market Price

For example, say the bond is currently at $920:
$60=6.5%
$920

Question 39

Yield to Maturity-Bonds

Answer 39

This measures the investor’s total return if the bond is held to its maturity date. That is, it includes the annual interest payments, plus the difference between what the investor paid for the bond and the amount of principal received at maturity.

Question 40

Duration:Bonds

Answer 40

Duration is the primary measure of bond price volatility. It takes into account both the length of time to maturity and the difference between the coupon rate and the yield to maturity. Here are some of the most important facts about duration:

The longer the duration of a particular bond, the more its price will fluctuate in response to interest rate changes.
Duration is always equal to or less than the years to maturity of the bond.
Duration can help to calculate the impact of interest rate changes on the price of the bond. For example, a bond with a duration of eight is likely to decrease 8% for every 100 basis points increase in market interest rates.
Duration is a weighted average term to maturity.
As payment frequency increases, duration decreases

Question 41

Long Position Traded by investors

Answer 41

Investors with this position believe that the price of the stock will rise, and expects to profit in the future by selling their stock.

When the investor eventually sells this long position, the sale is known as a long sale.

Long positions have limited risk as the investor can lose only what was paid for the stock, as well as any capital gains.

Question 42

Short Position Traded by investors

Answer 42

Investor expects the price of a stock to fall.

The customer initially borrows the stock from a broker-dealer to sell in the market, expecting that the stock’s price will go down.

At a later date, the investor plans to buy the stock back at a much lower price to replace the borrowed shares (known as closing the short position) while making a profit - that is, the difference between the original sale price of the borrowed shares and the value of the stock purchased back at a lower price.

Note that a short sale is a risky position for an investor to assume. Instead of declining towards zero, the price of the shorted stock could actually rise to an infinite, or unlimited, degree. (In other words, the position has unlimited riskassociated with it.) If this scenario were to occur, the short seller would be obligated to replace the original, borrowed stock at a price much higher than the initial sale price.

Question 43

Market Orders

Answer 43

most common types of orders. The order merely instructs the broker to buy or sell a stock at whatever price is available when the order reaches the floor of the exchange. While the customer will not know the price at which the stock was bought or sold until the order is completed, a market order will always be executed.

Question 44

Limit Orders

Answer 44

A limit order is executed at a specified price or better. A buy limit order is executed at the order price or lower, while a sell limit order is filled at the specific limit price or higher. Unlike a market order, a limit order might not be executed if the price never reaches the specified limit price.

Question 45

Stop Orders

Answer 45

A stop order becomes a market order to buy or sell a security once the stock reaches a certain price, called the stop price.

Question 46

Stop-Limits

Answer 46

A stop-limit order is a combination of both a stop and a limit order. The stock must reach the stop price to activate the order, but once it is activated, the order becomes a limit order, which will only be filled at a specific price or better

Question 47

Day Orders

Answer 47

order is cancelled at the end of the trading day if it has not been executed.

Question 48

Good Till Cancelled (GTC) Orders

Answer 48

This type of order remains in place until it is executed or cancelled by the customer.

Question 49

Firm Quotes

Answer 49

A firm quote is the price at which a broker-dealer or market maker will buy or sell at least one trading unit of stocks (100 shares) or bonds (five bonds) at the quoted price. For instance, a firm market for a stock sounds like, “The market is 54-55”, or “It is 14-14 ½”.

Question 50

backing away

Answer 50

If the market maker refuses to do business at the firmly quoted price after the fact, his or her action is called backing away

Question 51

Subject Quotes

Answer 51

subject quote is given when the price is tentative, subject to the market maker’s reconfirmation. The market maker may state, “It’s 20 to 22, work out”, or “The price is around 78-78 ¾”.

Question 52

Qualified Quotes

Answer 52

allow the broker-dealer to back away from the quote if market conditions change in the security. Two types of qualified quotes are recognized: workout quotes and nominal quotes.