Knowledge of Capital Markets

Question 1

Securities Exchange Commission (SEC)

- Date, authority, goals

Answer 1

Date: Established by Securities Exchange Act of 1934 under Franklin D. Roosevelt

Authority: SEC has authority to propose, draft, and enact laws in furtherance of its purpose. Authority to file civil and criminal law suits against violators.

Goals: protecting investors; maintaining fair, orderly, and efficient markets; facilitating capital information

Question 2

CBOE Global Markets (SRO)

Answer 2

owns the largest options exchange in US

creates all rules for options exchanges and can enforce them

Question 3

Financial Industry Regulatory Authority (FINRA)

Answer 3

is an SRO accountable to the SEC

Develops and implements rules specifically for brokerage firms and their employees

All firms trading securities must be registered with FINRA

Question 4

Municipal Securities Rulemaking Board (MSRB)

Answer 4

Establishes rules that banks and securities firms must follow when buying, selling, underwriting, or recommending municipal securities

Question 5

Department of Treasury

Answer 5

Part of Executive branch of government, works with Fed to foster economic growth

Treasury collects taxes and initiates borrowing on behalf of the government through Treasury securities (T-bills, notes, bonds)

Uses IRS to actually collect taxes

Question 6

North American Securities Administrators Association and Blue Sky Laws

Answer 6

association devoted to investor protection

creates “model” laws that states can use

These laws that states use are called “blue sky laws”

Question 7

Federal Reserve Board (FED)

Answer 7

network of regional banks operating under authority of federal government

Responsible for decisions that affect stock market and economy (setting interest rates and raising money supply)

Question 8

Securities Investor Protection Corporation (SIPC)

Answer 8

protects clients of brokers and dealers in case of financial failure

SIPC covers up to $500,000 of the equity balance, which includes up to $250,000 in cash

Question 9

Federal Deposit Insurance Corporation (FDIC)

Answer 9

Same as SIPC, but for traditional banks

Insures a bank account up to $250,000

Member banks pay dues to fund FDIC

FDIC has $1b line of credit with US Treasury

FDIC monitors banks to ensure adequate capital, not excessive risk, fraud prevention, and rule following

Question 10

Types of Investors

Answer 10

Institutional Investor: investors with immense amounts of capital. Ex: commercial banks, investment banks, hedge funds, insurance companies

Retail Investor: individuals investing for their future through common vehicles

Accredited Investor: investors with sufficient net worth, annual income/expertise. They do not require same level of protection. Can buy & sell unregistered securities (PE) governed by Regulation D of Securities Act of 1933

Question 11

Broker-Dealers & Types of Broker Dealers

Answer 11

Financial institutions that affect securities transactions on behalf of individuals and entities or for their own accounts.

Broker: when affecting transactions on behalf of others

Dealer: When affecting transactions on behalf of their own account

Introducing Broker: individual or organization that solicits or accepts orders to buy or sell futures contracts, forex, commodity options, or swaps

Clearing Broker: Ensure proper settlement of transactions

Prime Broker: provide higher level, specialized services to hedge funds or other large clients

Question 12

Municipal Advisors

Answer 12

entities that specialize in financing of local governments through bond offerings.

Required to register with SEC and pass MSRB Exam (Series 50)

Question 13

Issuers and Underwriters & Types of Underwriting

Answer 13

Used as guidance during securities offerings

Best Efforts Underwriting: IB is only required to place as much of issuance as is possible given market conditions. Not responsible for purchasing remaining shares.

Commitment Underwriting: IB is required to buy all remaining shares of issuance.

Question 14

Traders and Market Makers

Answer 14

Market Maker: specialists who make sure there is sufficient liquidity. Main point of contact for company and tells them who has been trading stock and what trading conditions are like.

Traders: market participants that engage in capital markets for variety of reasons for their own accounts, could be for hedging.

Question 15

Custodians and Trustees

Answer 15

Custodians: hold onto securities for safekeeping. Ensure that the securities an investor owns are actually in investors account. Ex: Fidelity, Schwab

Trustees: Trustee manages the Trustor’s assets, has fiduciary duty

Question 16

Transfer Agent

Answer 16

typically a commercial bank that works for corporation that maintains records of all equity and bondholders. Important for events like rights offering or dividends.

Question 17

Depository Trust and Clearing Corporation (DTCC) and Options Clearing Corporation (OCC)

Answer 17

DTCC: Serves as a custodian and identifies proper owners of securities.

Also serves as clearing agent, makes sure all settlement procedures are honored

OCC: guarantees each side of an options contract is fulfilled

Question 18

4 Types of Markets

Answer 18

Primary Market: This is where new securities are created (ex: IPO’s)

Secondary Markets: This is where securities are traded between investors (ex: NASDAQ). These markets establish price through competitive bidding and have requirements for firms to trade on these markets.

Third Market: OTC market. Traded through telephone and computer network rather than organized exchange. Much smaller companies. Regulated by National Association of Securities Dealers (NASD) (ex: pink sheets)

Fourth Market: electronic network utilized by institutions only. (ex: known as “dark markets”)

Question 19

Monetary vs. Fiscal Policy

Answer 19

Monetary: concerned with the money supply and how that can effect the economy. Controlled by the Federal Reserve. Increased money supply = increased growth.

Fiscal Policy: concerned with government taxation and expenditures. Increased taxation = economic shrinking. Increased expenditures = economic growth.

Question 20

Open Market Activities (Operations)

Answer 20

Executed by the Fed to affect money supply. FRB of NY buys and sells US Treasuries

Fed buys US treasuries to increase money supply. This transfers money from Fed to market economy.

Fed sells US treasuries to decrease money supply. This transfers money from market economy to Fed balance sheet.

Question 21

Different Rates

Answer 21

Fed Funds Rate: rate that large banks charge each other for overnight borrowing of $1M or more. Volatile, short term interest rates.

Prime Rate: rate tha banks charge low risk customers (namely corporations) with good credit. This rate fluctuates based on money supply.

Discount Rate: rate that FRB charges to the Fed when bank is issuing short-term loans. Higher discount rate = more expensive for banks and customers to borrow.

Broker Loan Rate: rate that banks charge brokers and dealers when lending money for margin accounts (aka call loan rate or money rate)

Question 22

Business Cycle

Answer 22

Phase 1 - Expansion: Good business conditions; strong economic indicators; stock market, housing, and unemployment are good

Phase 2 - Peak: high point of expansion phase when economic indicators tend to be on downswing. typically less investing and spending

Phase 3 - Contraction: recession, or in extreme cases, depression

Phase 4 - Trough: downtrends begin to level off and stop; sets stage for new cycle of expansion

Question 23

Yield Curves

Answer 23

Represents interest rates for bonds of same rating with different maturities. Common yield: US 3 month Treasury vs 30 year.

Normal: upward curve between interest rates and maturity dates

Inverted Yield Curve: indicates a recession since bonds with longer maturities have lower yield rate

Question 24

Economic Theories

Answer 24

Keynesian: Increased or steady demand leads to more economic growth. Federal government must sustain economy by spending tax money on stimulating projects.

Monetarist: Inflation and deflation are direct result of available money supply. Not enough money = prices fall. Too much money = prices rise. Federal government must regulate money supply and stay out of markets. Gradually increasing money supply keeps demand without risking inflation.

Question 25

GDP vs. GNP

Answer 25

GDP: Total economic output that occurs within a nations borders

GNP: GDP plus or minus economic output that occurs outside of a nations border (income from foreign investments and income by foreign residents)

Question 26

Exchange Rates/Spot Exchange Rates/Spot & Forward Market and how they affect markets

Answer 26

The value of one currency compared to another. Affects value of foreign securities and costs for businesses to do business overseas.

Spot Exchange Rate: price to trade one currency for another at any given time

Spot Market: where exchange occurs immediately

Forward Market: where investors can lock in the exchange rate