Knowledge of Capital Markets

Question 1

What is the role of FINRA?

Answer 1

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.

Question 2

Define the SEC.

Answer 2

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.

Question 3

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

Answer 3

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

Question 4

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

Answer 4

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

Question 5

What is the CBOE?

Answer 5

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

Question 6

What is the MSRB?

Answer 6

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.

Question 7

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

Answer 7

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

Question 8

What is the NASAA?

Answer 8

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

Question 9

Describe The Federal Reserve.

Answer 9

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.

Question 10

Define SIPC.

Answer 10

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.

Question 11

How much is SIPC Coverage?

Answer 11

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

Question 12

What is the FDIC?

Answer 12

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.

Question 13

What type of deposit accounts are covered under the FDIC?

Answer 13

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.

Question 14

Define ‘retail investor’

Answer 14

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

Question 15

Define ‘institutional investor’

Answer 15

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

Question 16

Define ‘QIB’

Answer 16

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

Question 17

Define ‘accredited investor’

Answer 17

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.

Question 18

What is a carrying Firm

Answer 18

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.

Question 19

Introducing Firms

Answer 19

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

Question 20

What is a Prime Broker?

Answer 20

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.

Question 21

Investment Advisor

Answer 21

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.

Question 22

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

Answer 22

…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.

Question 23

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)…

Answer 23

…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.

Question 24

Define Market Maker

Answer 24

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.

Question 25

What is the DTC

Answer 25

The Depository Trust Company

Question 26

Explain SROs

Answer 26

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.

Question 27

Define Stagnation

Answer 27

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

Question 28

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

Answer 28

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.

Question 29

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

Answer 29

6 months or more.

Question 30

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

Answer 30

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.

Question 31

How might the FRB impact the money supply.

Answer 31

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

Tip: Prime Rate is set by member banks.

Question 32

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

Answer 32

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.

Question 33

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?

Answer 33

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.

Question 34

What is a “market maker”?

Answer 34

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.

Question 35

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

Answer 35

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.

Question 36

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

Answer 36

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.

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

Question 37

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

Answer 37

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

Question 38

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

Answer 38

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

Question 39

What is a Prime Account?

Answer 39

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.

Question 40

Define Investment Advisor.

Answer 40

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.

Question 41

Define “custodian” and compare with “trustee.”

Answer 41

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.

Question 42

What is a transfer agent.

Answer 42

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.

Question 43

What is a clearing agency?

Answer 43

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.

Question 44

What is the OCC?

Answer 44

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

Question 45

What is the “Third Market”.

Answer 45

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.

Question 46

What is the “Fourth Market”.

Answer 46

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.

Question 47

What is the difference between monetary and fiscal policy?

Answer 47

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.

Question 48

How is Money Supply defined?

Answer 48

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.

Question 49

What is the broker loan rate?

Answer 49

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.

Question 50

Describe Keynesian economic theory.

Answer 50

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

Question 51

Describe Monetarist Theory.

Answer 51

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.

Question 52

Describe Supply-side economics.

Answer 52

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.

Question 53

GDP vs. GNP.

Answer 53

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

Question 54

What is “best efforts” underwriting?

Answer 54

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.

Question 55

What is “firm commitment underwriting”?

Answer 55

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.

Question 56

What is an APO?

Answer 56

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.

Question 57

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

Answer 57

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.

Question 58

Define LGIP.

Answer 58

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.

Question 59

REITS are organized as….

Answer 59

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.

Question 60

What is Sovereign Risk?

Answer 60

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

Question 61

How long is a self registration valid for?

Answer 61

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.

Question 62

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

Answer 62

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.

Question 63

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?

Answer 63

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.