Knowledge of Capital Markets Flashcards by Leighton Webb

What is the role of FINRA?

The Financial Industry Regulatory Authority regulates all matters relating to investment banking (securities underwriting), trading in the OTC market, trading in NYSE-listed securities, and the conduct of FINRA member firms and associated persons. FINRA is a “self-regulatory organization (SRO) and functions under the SEC’s oversight.

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Define the SEC.

Created under the Securities Exchange Act of 1934, the Securities and Exchange Commission (SEC) is the securities industry’s primary regulatory body. BDs that transact securities business with customers or other BDs must apply and be approved for registration with the SEC. The SEC regulates all exchanges and trading markets.

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A broker-dealer that does not comply with SEC rules and regulations is subject to:

censure
limits on activities, functions and operations
suspension of its registration (or one of its associated person’s license to do business)
revocation of registration
a fine

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FINRA rules that protect the integrity of securities markets can be broken down into the following four sections:

Conduct rules
Uniform Practice Code (UPC): covers the technical aspect of trading and payment for securities transactions.
Code of Procedure (COP): covers the enforcement of FINRA rules and details the punishment of members who incur rule violations.
Code of Arbitration (COA): FINRA-run dispute resolution process to settle monetary disputes.

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What is the CBOE?

Chicago Board of Options Exchange. Regulates all matters related to standardized options and related contracts listed on that exchange.

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What is the MSRB?

Municipal Securities Rulemaking Board. Regulates all matters related to the underwriting and trading of state and municipal securities. Regulates but does not have enforcement powers.

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What is the structure of the US Treasury Department/IRS?

Executive department and the Treasury of the US federal government. Administered by the Secretary of the Treasure who is a member of the cabinet.

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What is the NASAA?

North American Securities Administrators Association. Provides insight from their unique perspective to the SEC and SROs (self-regulatory organizations).

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Describe The Federal Reserve.

The Federal Reserve Board (FRB) consists of 12 regional Federal Reserve Banks and hundreds of national and state banks that belong to the system. The FRB determines monetary policy and takes action to implement its policies including:

a. acting as an agent of the US Treasury
b. regulating the US money supply
c. setting reserve requirements for members
d. supervising the printing of currency
e. clearing fund transfers throughout the system
f. examining members to ensure compliance with federal regulations
g. auditing the deposit-taking activities of member banks.

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Define SIPC.

The Securities Investor Protection Corporation. Created under the Securities Investor Protection Act of 1970. Nonprofit membership organization where members pay assessments into a general insurance fund that is used to meet customer claims in the event of a BD bankruptcy. ALL BD BANKS THAT REGISTER WITH THE SEC MUST BE SIPC MEMBERS, EXCEPT:

banks that deal exclusively in municipal securities
firms that deal exclusively in US government securities and
firms that deal exclusively in redeemable investment company securities.

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How much is SIPC Coverage?

Basic coverage under SIPC is no more than $500K per separate customer. Of that, SIPC covers no more than $250K in cash.

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What is the FDIC?

Federal Deposit Insurance Corporation. An independent agency of the US federal government created during the Great Depression of the 1930s in response to widespread bank failures. The FDIC is an independent agency of the US government that insures deposits up to $250K for each deposit ownership category in each insured bank.

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What type of deposit accounts are covered under the FDIC?

Checking, savings, money market, CDs and self-directed IRA accounts. Investment products that are not deposits are not covered (e.g. mutual funds, annuities, life insurance policies.

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Define ‘retail investor’

an individual who makes investments such as the purchase of securities for her own personal account rather than an organization.

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Define ‘institutional investor’

An entity that pools money to purchase securities and other investment assets.

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Define ‘QIB’

Qualified Institutional buyer. Generally means the QIB owns and invests a minimum of $100M in securities on a discretionary basis.

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Define ‘accredited investor’

Someone who has a net worth of over $1M not including net equity in a primary residence and has had an annual income of over $200K in each of two most recent years and reasonable expectation of reaching same income level during current year.

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What is a carrying Firm

Also know as “clearing” firm, these BDs “carry” customer accounts and accept fund and securities from customers. They have the capability to do trade executions, clear and settle transactions, take custody of customer funds and securities and handle related back office tasks. Carrying firms must segregate customer funds and securities held in their custody from the firm’s capital and securities.

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Introducing Firms

also known as “fully disclosed firms” or “introducing BD” is one that introduces its customers to a clearing firm.

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What is a Prime Broker?

One member associate with a Prime Account to provide custody and other services, while other firms - called executing brokers - handle all trades placed by the customer.

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Investment Advisor

Anyone who as part of his business gives investment advice for compensation must register as an investment advisor under the Investment Advisers Act of 1940. BDs who provide advice for a fee are subject to registration under this act. Agents of investment advisers must register and pass the Series 65 or 66. Providing advice and not charging separately for it e.g. acting as a registered representative (RR) does not require registration as an advisor.

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Broker-dealers that transact securities business with customers or other broker-dealers must apply and be approved for registration with….

…the SEC. The Securities and Exchange Commission (SEC) is the securities industry’s primary regulatory body. Broker-dealers that transact securities business with customers or with other broker-dealers must apply and be approved for registration with the SEC.

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A person who looks to provide advice to a city government concerning the issuance of municipal debt securities would BEST be described as a(n)…

…municipal advisor. A municipal advisor is a person that provides advice to or on behalf of a municipal entity with respect to municipal products or the issuance of municipal securities.

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Define Market Maker

BDs who incorporate proprietary trading into their business model are known as market makers. As a market maker the BD trades in their own account attempting to profit. A firm making markets may be a carrying firm or a fully disclosed firm. Commissionable transactions are those done by brokers for customer accounts, not proprietary trades.

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What is the DTC

The Depository Trust Company

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Explain SROs

Self-regulatory Organizations. Function under the SEC’s oversight. Each SRO is accountable to the commission for enforcing federal securities laws as well as supervising securities practices within an assigned jurisdiction.

Define Stagnation

Economic “stagnation” refers to prolonged periods of slow or little economic growth, unusually accompanied by high unemployment.

The rate that commercial money center banks charge each other for overnight loans is…..

The federal funds rate. The federal funds rate is the rate commercial money center banks charge each other for overnight loans of $1 million or more.

According to the US Department of commerce, the economy is in a recession when a decline in real output of goods and services lasts….

6 months or more.

Under the Securities and Exchange Act of 1934, registration is required for….

Broker-Dealers. Under the Securities Exchange Act of 1934, broker-dealers and domestic exchanges are required to register with the SEC. Registration of securities and IPOs is a requirement of the Securities Act of 1933, sometimes called the Paper or New Issues Act. The SEC does not have authority over foreign exchanges.

How might the FRB impact the money supply.

Discount Rate
reserve requirements
buying or selling securities in the open market

Tip: Prime Rate is set by member banks.

The business cycle is generally viewed as having how many cycles.

4: Economists recognize 4 stages in the business cycle: peak (prosperity), contraction (decline), trough, and expansion (recovery). Because it is a cycle, there is no set starting point or end to the business cycle, but the 4 stages always occur in the same order.

A broker-dealer has a line of business restricted solely to the purchase and sale of securities with trade executions being handled by another member firm. Which of the following would best describe this type of firm?

Introducing/fully disclosed. A fully disclosed “introducing” broker-dealer is what the word implies—it introduces its customers to a clearing firm. Clearing firms (often referred to as carrying firms) hold their customer’s funds and securities as well as those of their correspondent introducing firms. Essentially, the clearing firm acts as the introducing firm’s back office. Because the risk associated with holding customer funds and securities is not present, net capital requirements are much lower for introducing firms than they are for self-clearing or carrying broker-dealers.

What is a “market maker”?

A market maker trades in a proprietary account to facilitate trading of a security and provide liquidity. Any entity, individual or institution, willing to accept the risk of holding a particular security in its own account to facilitate trading and provide liquidity in that security is known as a market maker or trader.

To ease its monetary policy, allowing consumers to borrow more easily, the Federal Reserve Board can…

Lower the discount rate (1 of several things it can do). Wanting to ease its monetary policy, which would allow consumers to borrow more easily, the Federal Reserve Board can lower the discount rate—the rate it charges its member banks for short-term loans. This frees up more money for its member banks to lend to consumers. The federal funds rate isn’t one charged by the FRB but instead by large commercial banks to one another.

What are the key purposes of the Securities Act of 1933?

The primary purpose of the Act of 33 is to require full and fair disclosure in connection with the sale of securities to the public.

Governs the new issuance (primary) market, which involves the money-raising activities of issuers.
Requires issuers to register their securities when selling to the public.

What are the key purposes of the Securities Act of 1934?

Governs trading markets for existing securities and registration requirements of BDs, BD employees, and exchanges.

What is the main purpose of the Investment Company Act of 1940?

Governs the regulation of packaged products such as mutual funds, closed-end funds, and unit investment trusts.

What is a Prime Account?

An account (generally an institution) with a prime broker that allows customer to select one member firm (the prime broker) to provide custody and other services, while other firms (called executing brokers) handle all trades placed by the customer.

Define Investment Advisor.

Anyone who, as a part of his business, gives investment advice for compensation. Must register as an investment advisor under the Investment Advisers Act of 1940. Agents of investment advisors must register and pass the Series 65 or Series 66 (for representatives with a Series 7). Providing advice and not charging separately for it, i.e. acting as a registered representative (RR) does not require registration as an advisor.

Define “custodian” and compare with “trustee.”

An institution or person responsible for making all investment, management, and distribution decisions in an account maintained in the best interests of another is known as a custodian. A trustee is an institution or a person responsible for making all investment, management and distribution decision in the best interests of another who has been legally appointed to do so.

What is a transfer agent.

The transfer agent for a corporation is responsible for:
-ensuring that its securities are issued in the correct owner’s name.
-canceling old and issuing new securities
-maintaining records of ownership
handling problems related to lost, stolen or destroyed certificates.

*The transfer and registration of stock certificates are two distinct functions that by law cannot be performed by a single person or department operating within the same institution.

What is a clearing agency?

A clearing agency is an intermediary between the buy and sell sides of a transaction. The clearing agency receives and delivers payments and securities on behalf of both parties. Two largest are the National Securities Clearing Corporation (NSCC) and Depository Trust & Clearing Corporation (DTCC). The DTCC is a member of the Federal Reserve System.

What is the OCC?

Clearing Agency. Options Clearing Corporation. Clearing agent for listed options contracts (e.g. those listed on US options exchanges.

What is the “Third Market”.

Nasdaq Intermarket, a trading market in which exchange listed securities are traded in the OTC market. BDs registered as OTC market makers in listed securities can do transactions in the third market.

What is the “Fourth Market”.

The fourth market is a market for institutional investors in which large blocks of stock, both listed and unlisted, trade in transactions unassisted by BDs.

What is the difference between monetary and fiscal policy?

Monetary policy is what the FRB engages in when it attempts to influence the money supply. Fiscal policy refers to the governmental budget decisions enacted by the president and Congress.

How is Money Supply defined?

M1: Most readily available type of money: currency in circulation and demand deposits (checking accounts) that can be converted to currency immediately. Most M1 is in demand deposits. M1 is the largest and most liquid.
M2: M1 plus….some time deposits (less than $100K) that are fairly easy to convert into demand deposits. Includes savings accounts, non-negotiable CDs, money market funds and overnight repurchase agreements.
M3: M1 plus M2…and time deposits of more than $100K and repurchase agreements with terms longer than 1 day.

What is the broker loan rate?

The interest rate banks charge BDs on money they borrow to lend to margin account customers. Also know as call loan rate or call money rate.

Describe Keynesian economic theory.

Demand for goods ultimately controls employment and prices and, as a result, the government fiscal policies determine the country’s economic health.

Describe Monetarist Theory.

Milton Friedman is considered the originator of the monetarist economic theory. Monetarists believe the quantity of money (i.e. the money supply) is the major determinant of price levels.

Describe Supply-side economics.

Holds that government should allow market forces to determine prices of all goods. Supply siders believe the federal government should reduce government spending as well as taxes.

GDP vs. GNP.

GDP (gross domestic product) is the economic output of all goods and services produced with a nation. GNP (gross national product) is ownership based.

What is “best efforts” underwriting?

Calls for the underwriters (syndicate) to buy securities from the issuer acting simply as an agent, not as the principal. Underwriters are not committed to purchase the shares themselves and are therefore not at risk. Two types: All or none (AON). Underwriter must sell all of its shares or cancel the offering. Mini-max. Sets a floor (or minimum) and max the issuer is willing to sell.

What is “firm commitment underwriting”?

Underwriters buy the securities and the resells to public at a higher price. Here underwriters are acting as the principals and not the agents. Underwriter takes the risk.

What is an APO?

The first time that a company issues shares to the public, it engages in an IPO (initial public offering). Later offerings are known as SPOs (subsequent primary offerings) or APOs (additional public offerings). The IPO and any SPO or APO are all issuer transactions and are, therefore, done in the primary market.

When choosing to issue additional bonds to the general public in order to raise more capital, a corporate issuer is engaging in….

A primary offering. A primary corporate offering is one in which the proceeds raised go to the issuing corporation. Primary offerings of bonds may be made by an issuer to the general public as an initial public offering (IPO) or, as is the case here, in an additional public offering (APO). Both are primary offerings.

Define LGIP.

Local Government Investment Pools. Established by states to provide other government entities within its borders such as cities, counties, school districts or other state agencies with a short-term investment vehicle to invest funds.

REITS are organized as….

Real estate investment trusts, as their name tells us, are organized as trusts. Assets held in the trust and the distributions made can impact the tax consequences for the trust. As an investment vehicle, shares are sold to investors and these shares sometimes trade on exchanges. Whether traded or nontraded, the shares are considered to be equity (not debt) securities.

What is Sovereign Risk?

The risk of default by a country on its debt instruments is specifically recognized as sovereign risk.

How long is a self registration valid for?

Once filed, a shelf registration is good for 2 years and allows the issuer to sell portions of a registered shelf offering over a 2-year period without having to reregister the security. However, a supplemental prospectus must be filed with the SEC before each sale. For a Well Known Seasoned Issuer (WKSI) this extends to three years.

Which of the following funds would most likely fall the most in a rising interest rate environment?

Interest rate risk is defined as a potential change in bond prices caused by change in market interest rates after an issuer offers its bonds. If interest rates rise post issuance, existing bonds (with a lower coupon) will be viewed as less attractive and will be priced in the market at a discount. Conversely, if rates fall, the existing bonds (with their higher coupons) will be viewed as desirable and will trade in the market at a premium. The prices of bonds with longer maturities will fluctuate more than bonds with shorter maturities as this interest rate differential is potentially longer-lived. In this question the T-Bond is the longest maturity security so it will have the greatest price fluctuation. Duration is a word that is often used to express a bond’s price sensitivity to interest rate swings. The T-bond fund has the longest duration of the choices offered.

If the U.S. balance of payments is currently running at a surplus, what’s happening to flow of dollars, value of the dollar, exports vs imports and balance of trade?

When the U.S. balance of payments is running at a surplus, the balance of trade shows a credit; that is, exports are greater than imports, meaning more dollars are flowing into the U.S. economy than out. When the value of the U.S. dollar is down, foreign goods become more expensive to U.S. buyers, but U.S. goods become more attractive to those with foreign currency in hand. This also leads to more exports of U.S. goods.

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Knowledge of Capital Markets Flashcards

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