Important Definitions in the Securities Industry

Question 1

before a security can be traded, it must be issued to the public through what is called the

Answer 1

Primary Market

Question 2

In order to sell securities to the public, issuers (companies) usually use the services of an investment bank, also known as an

Answer 2

Underwriter

Question 3

The investment bank purchases securities from the issuer at a discount and then sells them to investors in a

Answer 3

Primary Offering

Question 4

The difference between the price at which the investment bank purchases the securities from the issuer and the higher price at which the investment bank sells the securities to investors is called the

Answer 4

Underwriting Spread

Question 5

If a company issues more shares after an IPO, it is referred to as a

Answer 5

Follow-On Offering

Question 6

Both IPOs and follow-on offerings are considered part of the _____ market because the issuer (the company) is receiving the proceeds from the sale of the shares.

Answer 6

Primary

Question 7

While most issues of securities are subject to federal regulations, most major public offerings are exempt from state securities laws and regulations, which are often referred to as

Answer 7

Blue Sky Laws

Question 8

Secondary market transactions are executed by

Answer 8

Brokers and Dealers

Question 9

Brokers

Answer 9

are individuals or firms that act as liaisons between the buyer and seller and take a commission for doing so.

Their transactions are called agency transactions, since the individual broker or brokerage firm is acting as an agent for the buyer and seller.

Question 10

Dealers

Answer 10

on the other hand, are individuals or firms that buy and sell securities out of their own inventory of securities.

Rather than brokering a deal for another party, a dealer is said to be a principal to the trade. That’s because a dealer is risking its own money, and the transaction adds to or depletes the dealer’s own account. For this reason, dealer transactions are often referred to as principal transactions. Dealers put their own money at risk and profit from the price difference between what they paid for the security and what they sold it for.

Question 11

A registered representative

Answer 11

is any person who solicits or conducts business in the investment banking or securities business. The term includes research analysts and back-office personnel. Most clerical or customer service employees do not fall under the category of registered representative and therefore do not have to register with FINRA.

Question 12

A registered principal

Answer 12

is a person actively engaged in the management of the firm’s investment banking or securities business, including sole proprietors, officers, partners, and managers. Principals are the managers working in a broker-dealer.

Question 13

An associated person

Answer 13

is a person employed by a broker-dealer. Associated persons include all registered representatives and principals. The term includes any partner, officer, director, or branch manager. It also includes entities and persons controlling or controlled by the firm (such as a subsidiary). Those whose jobs are solely clerical or ministerial are excluded from the definition of associated persons for purposes of registration. Examples of “clerical or ministerial” jobs include secretarial work, human resources positions, IT jobs that involve no access to customer accounts or securities, and certain customer service positions that do not involve sales.

Question 14

The exam may want you to know what is considered an equity security under the Securities Exchange Act of 1934. According to the Act, equity security is defined as:

Answer 14

• Stock or similar security
• Certificate of interest or participation in any profit sharing agreement
• Preorganization certificate or subscription
• Transferable share
• Voting trust certificate or certificate of deposit for an equity security
• Limited partnership interest
• Interest in a joint venture
• Certificate of interest in a business trust
• Any security future on any such security
• Convertible security
• Warrant
• Right to subscribe to or purchase such a security
• Option, such as a put, call, or straddle

Question 15

The U.S. supreme court added detail to that definition when, with “The Howey Decision,” it came up with four characteristics that define a security. A security involves

Answer 15

1) an investment of money that (2) involves a common enterprise (3) in which the investors expect to make a profit, and (4) the profits will be derived from the efforts of someone other than the investor. This definition will help you to determine whether a particular example on the exam is an investment contract or not.

Question 16

Specific examples of securities include:

Answer 16

Stock (preferred or common shares, treasury stock)
• Bond (corporate or government)
• Mutual fund (regardless of what it invests in)
• Option (puts, calls, futures, etc.)
• Oil and gas partnership

• Certificates of deposit for a security (American Depository Receipts (ADRs) and Global Depository Receipts (GDRs))
• Voting trust certificate

• Warrants or Rights for a security

• Pass-through certificates (mortgage-backed securities, CMOs)
• Investment contracts (see Note below)
• Real Estate Investment Trusts (REITs)

Question 17

The following are not considered securities:

Answer 17

• Commodities such as gold, pork bellies, and frozen orange juice
• Futures contracts on commodities
• Precious metals
• Currency, such as rare coins
• Real estate
• Antiques and collectibles
• Retirement plans (e.g., IRAs and Keogh plans)
• Fixed annuities and other insurance contracts that don’t have a “variable” feature allowing the owner to pick their investments out of a menu of choices. In other words, if you see the word “variable” associated with an insurance contract, it is subject to securities regulation. Common types of insurance contracts that are not securities include term life, whole life, universal life, and endowment policies.