Chapter 3 - Secondary Market Flashcards
- this is one of the two classifications of stock in the Secondary Market
- most investors start with this type of stock position
- an investor in this stock position owns the stock and has not sold
- an investor in this type of stock position is optimistic about the stock and believes that it will increase in price
– this type of investor is called a Bull because he/she anticipates that the stock price will rise in the future
- an investor with this type of position can theoretically lose the entire investment, but no more
Long Position
- this is one of two classifications of stock position
- this stock position is suitable for an investor that is pessimistic about the stock’s future performance
- a pessimistic investor is referred to as a Bear
- a Bear will sell the stock when it is high, hoping to buy the stock later when it is low
- the Bear establishes this type of stock position by borrowing the stock. The Bear then sells the borrowed stock with the obligation to replace it in the future
- an investor with this type of stock position has potentially unlimited risk
– someday the short seller must buy shares of the stock that were borrowed and return them to the lender. No substitutions are allowed
Short Position
- executes trades as either broker or dealer, but never both
– if the firm only matches up a buyer and a seller, then it is acting as broker. The firm is said to be acting in an Agent capacity and charges a commission. Acting in this capacity involves no risk
– if the firm uses its inventory account, it is said to be acting as a dealer. The firm is acting in a principal capacity and charges a markup. On the other hand, if the principal buys/places a security into its own inventory it charges a markdown. This always involves risk because there is no assurance the principal can sell the security quickly for a profit
Broker/Dealer
- also referred to as the Trade Ticket
- this term is the original record that documents the buy-or-sell transaction
- certain info is required to be on each ticket, such as:
– name of the security, symbol, account number, price, quantity, and whether the trade is solicited, unsolicited, or discretionary
– if the ticket is for a sell, it must be marked “long” or “short”
— for long sales if the b/d is not holding the securities in street name the RR must receive affirmation by from the customer that the customer can deliver the securities by the settlement date
— for short sales, the RR must receive affirmation from the customer concerning the source of the borrowed securities. Short sales must also abide by Regulation SHO
- three time stamps are required on the ticket. When the order is received, when the ticket hits the trading desk, and when the trade is executed
- the ticket must be adjusted if there has been a stock split or stock dividend
Order Ticket
- under this regulation, if the b/d misses 13 consecutive settlement dates on a threshold security, the b/d is required to perform a mandatory buy in
Regulation SHO
- a security with a large short position where the b/d might be at risk of covering the short
Threshold Security
- this must be sent to customers no later than the completion of the transaction or settlement of the trade
- the following info must be included:
– The b/d name and address; Whether the trade was a purchase or sale; Complete security description; Quantity; Trade date and settlement date; Delivery and payment instructions; Capacity of the b/d (agent or principal); Commission (if b/d is acting as agent); and Markup or markdown (if b/d acted as principal in a NASDAQ or riskless principal trade)
– the member firm is required to disclose the amount of mark-up or mark-down it applies to trades with retail customers in these securities if the member also executes an offsetting principal trade in the same security on the same trading day
Trade Confirmation
- this figure is the difference between the bid price and the offer/ask price
- the market for a security is always the highest bid price and the lowest ask price
- a narrow spread between the bid and ask price indicates active trading in a security
Trading Spread
- the price at which investors can sell their shares
- this price represents the highest price that a purchasing dealer is willing to pay for a security
Bid Price
- also called the offer price
- this is the price at which investors can buy the shares
- it is the lowest price that a selling dealer is willing to accept
Ask Price
- this is a guideline (not a rule) used to determine whether a commission or markup is fair to the public
- this guideline applies to nonexempt (corporate) securities traded in the OTC secondary market, and securities listed on an exchange
- this guideline does not apply to exempt securities (i.e. treasuries and municipals), nor to prospectus offerings
- this guideline also applies to miscellaneous bond wire services, proceeds trades, agency cross trades, riskless and simultaneous principal transactions, and other nonexempt stock and bond trades
- the Third Market also abides by this guideline
Five Percent Policy
- a physical location where b/d’s execute investor orders to buy and sell securities
Stock Exchange
- formed in 1792, this is the oldest and largest exchange market in the United States
- operates in seven liquid markets
- most active of the world’s stock exchanges
- securities must meet certain standards to be listed on the exchange
– must have at least 1.1 million shares outstanding, at least $140 million market value of shares, and aggregate pretax earnings over the last 3 years of $10 million. The share price must be at least $4 at the time of listing
- the trading of listed securities on an exchange is called the First Market; it is an auction market
New York Stock Exchange
- this term is the individual who has a seat on the exchange
- each firm that is a part of the NYSE must have an individual employee who owns a seat on the exchange
- there are four types of categories for these individuals
– Commission house broker or floor broker; Two dollar broker; Registered competitive traders; and the Designated market maker (DMM)
NYSE Member
- also referred to as the Floor Broker
- this NYSE Member executes orders for clients of the broker’s firm
- member firms charge a commission to their clients
Commission House Broker
- this NYSE Member executes orders for Floor Brokers when they are too busy to execute all of their firm’s orders
- this NYSE Member may execute orders for a number of Floor Brokers
- they charge each broker a commission
Two Dollar Broker
- this NYSE Member executes orders for their own accounts
- they seldom work for clients, but if they have a client order, they must give it priority over their own orders
Registered Competitive Trader
- this NYSE Member has the responsibility of maintaining a fair and orderly market
- this Member must buy when no buyers exist and sell when no sellers exist and hold these orders in his or her own account
- may also act as an agent for a Floor Broker
– this occurs when the Floor Broker cannot execute a client’s order due to price or timing
— this order is recorded in the term’s book and is held until it can be executed
—- if executed, the term charges a commission
- the term is also permitted to stop the stock for public orders meaning that the trader guarantees an order fill at a specified price for a period of time
- term’s act in a dual capacity meaning that they can either trade in their own account (principal) or they can act in an agency capacity on behalf of other member firms
- terms are committed to making an orderly market and must buy when sell orders are dominant and sell when buy orders are dominant
– when terms buy for their own account, they must buy higher than the highest bid. Vice versa, when selling they must sell lower than the lowest offerred
— in other words, terms must narrow the spread
- note that a term is not expected to go into default by supporting a market in a security that is dropping so rapidly. Meaning that terms cannot be forced to make a market in a worthless security
Designated Market Maker
- these orders are electronically sent to the exchange floor from a member firm’s office
- the system is called the NYSE super display book (SDBK)
- the trade goes directly to the DMM’s book and back again electronically
Wire Order
- this term provides the last trade information of the securities that trade on the exchange
- this information includes:
– Symbol, which is the unique character that is used to identify the company
– Shares trades. This number is expressed in round lots
– Price Traded
– Change direction. A symbol indicates whether the price is higher or lower than the previous day’s closing price
– Change amount. The difference from the previous day’s close
Consolidated Tape
- some shares trade in this term
- the public cannot see the number of shares traded, nor can they see the price per share
- these transactions come from large institutional investors
Dark Pool of Liquidity
- this occurs when an investor buys a security on one exchange and simultaneously sells the same security on another exchange
- this enables the investor to take advantage of small price deviations between the exchanges
- this is typically done with large blocks of securities
Market Arbitrage
- this is another form of arbitrage that is used in a merger and acquisition scenario
- the arbitrageur buys the stock of the company that is being acquired and sells short the stock of the purchasing company that is doing the acquisition
- there are also arbitrage opportunities with convertible securities
– this occurs when the arbitrageur purchases a convertible bond or preferred stock then converts to common stock
— this is favorable when the common shares are trading above parity
Risk Arbitrage
- this term begins with an order being generated by the order or wire department
- the purchase and sales department then processes the orders
- the margin department then reviews all orders
- the order then goes to the cashier cage
- O > P > M > C
Order Flow
- also known as “crossing the market”
- occurs when an order to buy and an order to sell come in to the member firm from two different customers for the same stock
– the order must first be offered on the exchange floor for $0.01 higher than the current bid for at least 16 seconds before the b/d may cross the transaction within its own client base
Cross Transaction
- this is a security purchase or sale where no price is specified
- the order must be exercised immediately at the prevailing or current market price for that particular security
- if multiple of these orders are received, the exchange will determine which orders get filed first based on priority (time), precedence (size), and parity (coin toss)
Market Order
- this is an order to buy at or below a specified price, or to sell a stock at or above a specified price
- this is a conditional order designed to avoid the danger of adverse unexpected price changes
- this type of order is not guaranteed and market order have priority of this type of order
– it is not guaranteed because it is a day order unless entered good till cancelled
Limit Order
- this type of order must be placed below the market, and instruct that if a stock goes down to the stop price, the stop is elected
- once the stop has been elected, the order becomes a market order for immediate execution
- this type of stop is placed at or below support for a stock
Sell Stop
- this type of order must be placed above the market, and is executed at or above the stop price
- once the market hits the order price, and releases the stop, execution is at the very next trade
- this type of stop is placed at or above resistance on a stock
- this type of stop is used as protection from short sales where the position has unlimited risk from market appreciation
Buy Stop
- this type of order is entered below current market price
- the order is triggered when the stock price trades at or below the stop price
- the order then becomes a live limit order that will only be executed at a designated price or better
- this type of order can be used for protection of long positions or to take short positions
Sell Stop Limit
- this type of order is entered above current market value
- the order is triggered at or above the stop price, then becomes a live limit order, to be executed at or below the limit price
Buy Stop Limit
- this type of order is a market order that gives the floor trader time and price flexibility
- the floor broker may fill this type of order at any time throughout the day that the floor broker things is best
- this is not a discretionary order
- all orders are day orders and are cancelled unless entered as GTC
Not Held Order
- quantity takes priority over time in this type of order
- these orders do not have to be filled immediately and are considered day orders which must be executed or canceled by the close of the trading day
All or None Order
- this type of order prioritizes both quantity and time
- the order must be executed in its entirety at the time of order entry
- this type of order is not placed in the specialist’s book and must be killed if not immediately executed
Fill or Kill Order
- this type of order prioritizes time
- when the order is placed, it must be filled immediately with as many shares as are available
– if the order is partially filled, the unfilled amount is cancelled
Immediate or Cancel Order
- also referred to as Market Orders at the Close
- this type of order is entered to be filled at the close of the trading day
- the order is canceled and must be re-entered if there is a trading halt that prevents the order from being filled
Market on Close
- this type of order is done off of the floor and off tape
- this order usually involved taking a block trade on a low-priced, comparatively thinly traded stock into the Third Market (OTC - NASDAQ) and dribbling the order in slowly throughout the trading day rather than all at once on the exchange
Block Order
- this market is a decentralized, 24-hour market that takes place over telephone lines and the internet
- it is the world’s largest market for equities and debt
- this market is a Negotiated Market (contrary to the NYSE, which is an Auction Market)
Over the Counter (OTC) Market
- this is the electronic quotation system that hosts shares of the largest corporations that trade OTC
- the stocks quoted must meet the listing requirements, which include asset size and numbers of outstanding shares
- this market is open to all firms that are members of FINRA
- any firm is allowed to register as a market maker for a particular security if they meet minimum requirements
- the FINRA member firm may subscribe to the NASDAQ system in three different levels
NASDAQ
- this gives the seller the option to deliver the security during any time period ranging from 6-60 business days
- this is called a negotiated settlement and also locks in the right to buy and sell the security at a specific price
Seller’s Option
- this entity provides liquidity for all OTC stocks, both NASDAQ and non-NASDAQ
- the entity is always a broker/dealer, however, not all broker/dealers are this entity
– this is because some b/d’s either do not have the capital or choose not to risk their capital to make a market in a security
Market Makers
- this refers to the trading of exchange-listed securities in the OTC market
- this market has no physical location and all trading in this market is done electronically
- securities in this market include: any exchange-listed stocks; ADR’s; Rights or Warrants
- trades large enough to create an order imbalance in a particular stock will be done in this market (OTC)
- part of this market is represented in the Consolidated Tape
– this is an attempt by the SEC to provide for centralized trading info on all actively traded US equities, wherever they may be traded
Third Market
- this term is designated by FINRA in certain listed stocks trading on NASDAQ
- required to register as Designated Reporting Members (DRM’s)
– if both firms are DRM’s in a security, the sell side is required to report the transaction within 10 seconds
– if both firms are not DRM’s (non-reporting), the sell side reports the transaction within 10 seconds
– if just one firm is a DRM, then the DRM reports the transaction within 10 seconds
Third Market Makers
- this term contains inter-dealer net and last trade info on corporate notes and bonds
Yellow Sheets
- this term consists of Institutional Investors (i.e. mutual funds & pension funds) electronically trading big blocks of securities with one another
- These investors use Electronic Communications Networks (ECN’s)
– ECN’s facilitate Agency Cross Services, taking the shares from the seller and providing them to the buyer electronically, and provide confirmation records to each institution
— this is a less costly way of trading because without a middleman, there are no commissions
Fourth Market
- this term is a violation that occurs when the b/d places another firm between itself and the customer
- this is only allowable if it provides a better price to the end customer
- b/d’s can choose to direct or route their orders through systems available for order routing, such as Advanced Computerized Execution System (ACES), which are usually used by order entry firms
– b/d’s must disclose their order routing policies quarterly to FINRA
Interpositioning
- linked Electronic Communication Networks (ECN’s) use Trade Reporting Facilities for this term
- if the firm is using an Alternative Display Facility (ADF) and on an unlinked ECN, the system used for this term is TRACS (Trade Reporting and Comparison Service)
- OTC Reporting Facility (ORF) is used to report OTC non-NASDAQ
Trade Reporting
- this term is used to track orders that have been placed by b/d’s
- the system audits orders based on the timestamps to make sure that the firm was not front running the customer order and was providing the customer with best execution
Order Audit Tracking System
- this reports trades by b/d’s who complete transactions in US treasury and corporate bonds
- this term requires that both the buy and sell side report within 15 minutes of the transaction
- once both sides of the trade report through this term, FINRA will release the info to the public immediately
TRACE
- this is the MSRB system which tracks municipal bonds
- this makes the info available and provides greater bond market transparency to the public
Real Time Transaction Reporting System
