Chapter 8- Trading securities 20-25 questions Flashcards
Basics of The Securities Exchange Act of 1934 (The Exchange Act)
Established the SEC and it’s power to regulate broker/dealers, exchange, and OTC markets to maintain fair and orderly market
Requires registration of exchange members and those who trade
Provides for all the following: Creation of SEC Regulation of exchanges Regulation of OTC Regulation of credit by Fed Reserve Board Registration of broker/dealers Net capital rules Regulation of insider transactions, short sales, and proxies Regulation of trading activities Regulation of client accounts Customer protection rule Filing of 10 K and Qs Regulation of officers directors and principal shareholders
Composition of SEC
Five commissioners appointed by president of US, approved by senate
Registration of Exchanges and Firms
Registration of Exchanges
1934- Requires Exchanges to file with the SEC
Exchanges agree to help enforce act
Copies of the bylaws, constitution, and articles of corporation are required
Must disclose any rule changes to be disclosed
Registration of Firms
Companies trading on exchanges or Some OTC must register with SEC
Must file 10Qs and 10Ks
Exchange Market
Composed of the NYSE and other exchanges.
Is referred to as an auction market
Listed security is any security listed on an exchange
Over the counter market
Second market
Where Securities not listed on the exchange are traded
Internet based
All Municipals and government bonds trade here
Equities are divided into Nasdaq and non Nasdaq
Nasdaq- Global Select Market, Global Market, and Capital Market
Non-Nasdaq- OTC pink and OTC bulletin board
Third Market (Nasdaq intermarket)
Broker dealers must be listed as OTC market makers
Exchange listed securities are traded in OTC as long as they are reported to Consolidated Tape in 10 seconds
Fourth Market
Institutional Investors
Large blocks of stock both unlisted and listed
Unassisted by broker dealers
Take place through Electronic Communication Networks and are open 24/7
Trading hours of the four markets
NYSE= 9:30-4pm OTC= same hours, though market makers remain open till 6:30 in extended hour trading
Larger spreads, Greater volatility due to low amounts of bid and asks in OTC
Trading location and pricing system for listed and OTC
Listed markets like NYSE and others have trading floors and central market places. Double auction market, and participants compete for best prices
OTC markets- less stringent trading criteria. Traded over network, no central marketplace.
Interdealer network- compete to post best bid and ask. Negotiated market
Quoted
Bid- Market maker willing to buy
Ask- willing to sell
Always spread present, bid below ask
Dark Pools of Liquidity
Trading volume or liquidity not openly available to public
Usually occur on crossing networks or Alternative Trading Systems (ATS) that match buy and sell orders without routing order to an exchange
Able to execute large block orders without impacting public prices or exposing investment strategy
Orders Can be placed anonymously
Market transparency is darkened
Trade Reporting Facility
FINRA Trade Reporting Facility (TRF)
Automated trade Reporting system operated on (Automated Confirmation Transaction) ATC
Used to report trades off of trade floor and NASDAQ
Broker
Agents that arrange trades for clients and charge COMMISIONS
Arrange trades between buyers and sellers
Do not effect trades as principal
Dealers or Principals
Buy and sell for own account, called position trading
Charge markups or mark downs to clients from the interdealer price
Trading from own supply
Net price includes the mark upon
Like a car dealer
Filling an Order
A broker/dealer can fill an order by:
- Acting as an agent by finding a seller and arranging the trade
- Buy the securities, mark it up and resell them
- Sell shares from inventory
Dealer must disclose amount of mark up if it is a Nasdaq security
Can a firm say as both the broker and the dealer in the same transaction?
Heck naaaaa
NYSE listing requirements
NYSE is the most widely known and often called the Big Board
Largest exchange
Stocks listed in NYSE can also be listed on regional exchange like Chicago Stock Exchange
Must meet a minimum size and minimum number of shareholders holding 100+ shares
Delisting
The NYSE reserves the right to delist a security
Reasons:
Failure to meet the minimum maintenance criteria
Bankruptcy
Abnormally low share price or share volume
Corporate actions not deemed in public interest
BOD of a company would have to vote to delist voluntarily
4 different Personnel (NYSE members) who can trade on floor
- Commission House Brokers (floor brokers)- Execute for clients and for own accounts
Now allowed to trade non-NYSE - Two-Dollar Broker- Called on when Commission Brokers are too busy to execute all trades. Charge a commission for services
- Registered Trader- Trade primarily for their own account. If they accept a public customer’s order from a floor broker must give that priority.
- Specialist or Designated Market Maker- Facilitate trading in specific stocks to maintain fair and orderly market.
Act as both broker and dealer, as well as a auctioneer
Receive rebates from trades done whenever their Quotes result in trades
Auction Market (double auction market)
Buying and selling of exchange securities
Both buyers and sellers call out bids
Best bid must be at least $.01 higher than current best
Best offer must be $.01 lower
Highest and lowest bid are always given first considerations
More than one order at the same price
Specialists award trades in following order
- Priority- First order in
- Precendence- largest order of those submitted
- Parity- Random Drawing
Market Wide Circuit Breaker Rules (MWCB)
Protects against volatility
Three Levels of Halt:
Level 1- 7% decline in S&P 500
Before 3:25- 15 minutes
At or after 3:25 pm- Trading continues unless level 3
Level 2 Halt = 13% decline in S&P 500
Before 3:25- 15 minutes
At or after 3:25- Trading continues till level 3
Level 1 and 2 can only happen once a day. So once level 1 is triggered level 2 would be next
Level 3 Halt= 20% decline in S&P 500
Any time- Trading done for the day
Existing orders can be closed during market close
Arbitrage
Profiting from temporary price differences
Could be due to Three types:
1. Market Arbitrage- Trading in more than one market
- Convertible Security Arbitrage- Converting bonds to stock and selling for profit
- Risk Arbitrage- Buying stock in acquired company and selling short the acquiring company’s stock
Additional Roles of the Specialist or Designated Market Maker
Try to minimize price disparity at open of trade by buying and selling from own supply when needed
Act as agents: execute all orders other brokers leave with them. Accept certain orders like limit and stop orders.
Act as Principal: Buy and sell in own accounts to make a market. May not buy stock at a price that would compete with current market.
Must avoid transacting business at opening or reopening that would upset public balance
Must file reports for exchange
May trade for his account between the bid and ask
Supplemental Liquidity Providers
Off-Floor Market Maker operates and competes with Designated Market Maker (DMM)
Must maintain a bid or an offer for 10% of day
Receives rebates as well, but not as large as DMM
May not trade for public customer or agency basis
Trading Posts
Horseshoe shaped trading center surrounded by computer terminals
DMM watches each trade but does not have to participate in all of them
Orders can also be submitted on Super Display Book
Crossing Orders
Two market orders for same stock, one to buy one to sell
Can use one order to fill both
Must first be offered in the trading crowd at a price higher than the bid by at least .01
4 Price restricted orders
Market
Limit
Stop
Stop Limit
Market Orders
Sent immediately to the floor without restrictions or limits
Executed immediately at current market price and has priority over all other orders
Guarantee of Execution
Buy executed at lowest offering price
Sell at highest bid price available
Limited Order
Limit of acceptable purchase or selling price
Executed at specified price or better
Placed on book to be executed if and when market price meets order
Buy Limit- Placed below current market price
Sell Limit- Placed above
Sometimes not executed even if Market temporarily hits price (FIFO)
Can be handled by specialist as a day order, sometime GTC
Order Protection Rule (SEC Regulation NMS)
Firm cannot buy or sell stock at Limit order and not fill a customer Limit order
Can execute partial order but may not deviate from price specified
Created an obligation for the firm to fill order if buying at that price
Stop Order (Stop Loss Order)
Designed to protect a profit or prevent a loss
Becomes a market order when a stock hits or moves through the price unlike a limit
Left with and executed by DMM
No guarantee of execution price
Buy stop orders are entered above current market price
Sell stop are below CMV
Triggered by an order being filled at the price of the Stop
Stop Order trades
Takes two trades to execute
- Trigger- Transaction to activate the trade
- Execution- Execution at next price available
May or may not be accepted depending on Exchange or dealer
Buy stop orders
Protects a profit or limits loss of a short position
Used by technical traders who track support and resistance levels of stock
Support is bottom, resistance is top
Would be executed once a stock traded for a specific price
Sell stop Order
Protects profit or limits loss of a long position
Also used by technical readers
Support is bottom line, Resistance is top
Stop Limit Order
Stop Order that becomes a Limit order instead of a market order upon hitting a certain price
Buy Stop limits and Orders
When would you buy?
Buy Limit- Below the market price and purchasing the share
Sell Limit- Above Market Price, would sell the share
Buy Stop- Entered Above the Market Price, and triggered when the market goes through
Sell Stop- entered below the market price and triggered as market order below that price
BLISS
Buy Limits and Sell Stops for orders being placed below market price
Specialist Display Book
Orders not immediately executed placed on Designated Market Maker book
Only rounds lots placed on book
Changing an order will result in a cancelation and replace pricess
Reducing Orders
All orders entered below market price are reduced on the ex-dividend date
Buy limits, sell stops and sell Stop limits are all reduced by the dividend due to the market opening lower
Sell Limits and buy stops are not
UNLESS ITS A DNR ORDER
Reductions for stock splits
If there is a stock dividend or stock split, all open orders are adjusted
Ex sell 100 XYZ at 50 Stop after a 2:1 stock split is 200 XYZ at 25 stop
If stock dividend makes odd lot, shares are sent to customer account but not included in orders
If there is a reverse split, all open orders are canceled
Day order
Unless marked otherwise, Stop or limit orders are usually day orders
Partially completed orders are acceptable and rest of order is unfilled
Good Till Cancelled
Valid until executed or cancelled
Automatically canceled if unexecuted on last business day of April or October
At the open and Market on close orders
At the open are executed at opening of market
Must reach post before time
Market on close must be entered before 3:40 pm
Not Held Orders
Coded NH
Floor broker given ability to decide best time and price to execute
May not be placed with the specialist
Day order under NYSE rules
Fill or kill Orders vs Immediate or cancel
Commission house broker instructed to Fill or Kill order immediately at the limit price or better
If cannot fill entirely the order is cancelled and originating branch office is notified
IOC orders- can be filled partially
All or None AON
Executed entirely or not at all. Can be day or GTC orders
Do not have to be filled immediately like an FOK
Alternative Orders (OCO)
One cancels the other
If stock is at $50 and customer wants to protect gain but doesn’t believe it will go much higher he might:
Sell a limit order of 53
Sell a stop Order of 48
Do Not Ship (DNS)
Do not execute on exchange other than NYSE
NYSE policy on orders
Does not accept:
GTC or Stop Orders or All or None or fill-or-kill orders
Broker dealer may, but NYSE will not
Regulation SHO
The SEC in 2004 did a pilot program suspending the tick rule and bid test rule
2007- voted to end price restrictions on short selling
However, the locate requirement (finding the shares attributed to a short sale) is still in place
SEC 1934 regulation on short sales
Prohibits directors, officers and principal stockholders from selling short
Sell Order SEC
SEC requires that all sell orders be identified as long or short
Person is long if:
- Has title to it
- Has purchased or is going to purchase
- Owns a security convertible into or exchangeable for it and has tendered it for conversion
- Has an option to purchase
Regional Exchanges
Tend to focus on securities within the region
Also offer trading in many securities of NYSE
Usually list smallest and newest company’s in their industry
Nasdaq OMX PHLX
Floor based and electronic trading due to NASDAQ taking over Philly exchange
Super Display Book (SDBK)
Used to route an order directly to the appropriate equity post
Can be sent preopening or post opening
The computer matches trades before the opening and leaves the rest on the computer for the Designated Market Makers to trade
All NYSE stocks are eligible
Consolidated Tape System (CTS)
Receives, validates, and sequences last sale price and size of all equity transactions in listed securities
Distributed over two networks:
Network A- Trades on NYSE floor, regional exchange, third market and the ECN
Network B- Last sales for securities listed on NYSE AMEX, trading solely by regional exchanges, local issues and bonds
Two Tapes
High Speed- Prints market identifiers, letters of security, price and number of shares
Low Speed- tradition right to left
Do not include commissions, markups and markdowns
Active Market Ticket
May signify the deleting of info
Digits and Vol Deleted: instead of 200 shares of IBM at 92.50, IBM2.50
Repeat prices omitted: only show different prices
SLD: means the exchange missed a trade and a higher price is not a sign of market rise
OPD: Initial transaction in which an opening was delayed
HALT: Means that trading halted for the security
The Over the counter market
Broker dealers negotiate trades directly with one another
Competitive computer network trading system
Trading includes but not limited to: ADRs Common stock Most corp bonds typically convertibles Munis US gov Preferred stock Equipment trust certs Closed end invest Warrants
Market Makers must be registered with both SEC and FINRA
Traded across the country
Market Makers must be registered with FINRA and SEC, where as NYSE only have to be with SEC
FINRA
Self regulatory organization for the OTC market
NASDAQ
Tracks OTC equities trading
Includes: Common stock Warrants LPs ADR Convertible bonds
Not nonconvertibles
Order Audit Trail System
Automated system created to record information relating to orders, quotes and other trade info from all equities
Tracks order from time of entry until execution or cancelation
Reports order by order to FINRA
OTC market Makers
OTC does not have specialists
Firms must register with FINRA to buy and sell
Buy and sell from own inventories, for own profit and own risk
Act as a principle in most cases
Current Bid, Current Offer and Spread
Bid- Highest price at which dealer will buy
Offer- lowest price it will sell
Spread- difference
Customer flips
Short hand quote 43.25 to .50 (43.25-43.50)
Does not include mark up or mark down
Net prices do
Firm Quotation
Price at which a market maker stands ready to buy and sell one trading unit (100 shares)
All quotes are firm unless otherwise stated
Can make counter offer but only way to guarantee execution is to buy at market
Market maker can revise in response to market conditions, but cannot back away (trading violation)
Recognized quotation
Any public bid or offer for one or more round lots
Must state amount of securities if under a round lot
Bid must be good to split apart
Subject Quote
Price is tentative
Subject quotes are hedged and not absolute
Firmed up after transaction size is known
Qualified Quotes
Phrases used to allow broker/dealer to back away if Market conditions change
Two Types of Qualified Quotes
Workout Quote- if an offering is too large, it might be used
Approximate figure used to provide buyer seller with indication of price, not a firm quote
Nominal Quote- Someone’s assessment of where a stock might trade, must be marked not actual price
Factors effecting spread
Issues size
Issuers financial condition
Amount of market activity
Market conditions
Size of a quote
Will always be one round lot (100 shares)
Non-Nasdaq Pricing
Securities quoted on OTC Pink or OTC bulletin, three Quote rule
Broker/dealers receiving orders to buy and sell must contact 3 dealers for a prevailing price
Important Test Points on OTC Quotes
Markups and Mark downs are charged when a market maker is acting as principal
Firm quotes are one round lot only
11-11.50 3x5 is firm for 300 shares at a bid of 11 and 500 shares at 11.50
Nominal quotes can be given for informational purposes only
Wide spread indicates thin trading market
The 5% Markup Policy
Guideline only and not a firm rule
Above or below may be in violation of fair and equitable trade practices
5% markup based on price of inside market price
Applies to all nonexempt listed or unlisted securities or OTC
Policy applies to commissions as well
Does not apply to mutual funds, variable annuity contracts or securities sold in public offerings or municipal securities
All of which are being sold by prospectus
Dealers inventory costs
If a customer order is filled from inventory, the net price is based on the current market price
Cannot take into account what the security was acquired for
Riskless and Simultaneous Transactions
Order to buy or sell stock in which firm is not a market maker
Dealer has two options:
Buy as an agent and charge the customer a commission
Buy or sell for its riskless principal account
Must disclose markup to customer if acting as a principals
Proceeds from Transactions
If a customer sells securities and uses the proceeds to buy something else, must considered it one transaction
Only allowed to charge a total of 5%
Factors to be considered in markup mark down
Type of security- More risk is a greater justification for charging higher markup
Inactively traded stocks- thinner the market, the more volatile
Selling price of security- commission and markup rates should decrease as stock prices increase
Dollar amount of transaction- lower dollar amount = higher transaction fee
Type of broker
Pattern of markups
Markups on Inactive stocks
Markup may be okay if reasonable
Nasdaq Quotation Service
Nasdaq level 1- available to registered reps.
Displays inside market price only
Cannot guarentee a price due to fluctuations
Nasdaq level 2- approved subscribers only. Current quote and size available from each market maker. Must be guaranteed for 100 shares
Nasdaq 3: subscribers access to level 1 and 2 and allows registered market Makers to input and update quotes in all securities they make a market
Market maker Transaction Requirements for NASDAQ
Must include symbol, number of share, transaction price and whether trade was a buy sell or cross
10 seconds to report
Must make daily report of volume trades
Inside market
Represents best bid and best ask
Four Bid Asks 10-11 10.13-10.75 10.25-11 10.13-10.88
Inside market is 10.25-10.75
Nasdaq market maker reporting
Must report within 10 seconds
Registered market Makers must make daily report of volume
One sided quotes
Only allowed on the OTC Bulletin Board
A short sale can be executed on
Plus tick
Zero plus tick
Minus tick
Zero minus tick basis
Who sets the opening quote for issues listed on the NYSE
The specialist (designated market Makers)
Who is employed by a member of the Exchange
A customers order to sell for the week only is entered
GTC
The broker dealer is responsible for closing out the position
OTC Pink
Quotes are not firm and updates may not be current or made intraday
