NASDAQ Market/OTC Market

Question 1

Which two of the following are securities that TRADE in the over-the-counter market?

I Mutual Funds
II Government Bonds
III Variable Annuities
IV Master Limited Partnership Direct Participation Programs

A. I and II
B. III and IV
C. I and III
D. II and IV

Answer 1

The best answer is D.

Mutual funds and variable annuities are redeemable securities - they are non-negotiable and cannot trade. Redeemable securities are issued by the sponsor and are redeemed with the sponsor at Net Asset Value. Government bonds are negotiable, and are the most actively traded security. Do not confuse government bonds with so-called “savings bonds” - Series EE and HH issues. Savings bonds are non-negotiable. In regard to Direct Participation Programs, limited partnership interests are rarely traded because the market is very thin. However, they are negotiable. Certain limited partnerships (so-called “Master Limited Partnerships”) are exchange listed and trade actively like any other listed security.

Question 2

Which two of the following are redeemable securities that are NOT traded in the “over-the-counter” market?

I Mutual Funds
II Government Bonds
III Variable Annuities
IV Master Limited Partnership Direct Participation Programs

A. I and II
B. III and IV
C. I and III
D. II and IV

Answer 2

The best answer is C.

Mutual funds and variable annuities are redeemable securities - they are non-negotiable and cannot trade. Redeemable securities are issued by the sponsor and are redeemed with the sponsor at Net Asset Value. Government bonds are negotiable, and are the most actively traded security. In regard to Direct Participation Programs, limited partnership interests are rarely traded because the market is very thin. However, they are negotiable. Certain limited partnerships (so-called “Master Limited Partnerships”) are exchange listed or NASDAQ listed and trade actively like any other listed security.

Question 3

Which of the following securities is LEAST likely to trade “over-the-counter”?

A. U.S. Government Securities
B. American Depositary Shares
C. Preferred Stock
D. Options

Answer 3

The best answer is D.

Options are “listed” and trade on exchanges. There is virtually no options trading “over-the-counter.” U.S. Government bonds and municipal bonds are only traded “over-the-counter,” they do not trade on exchanges. Common stock, preferred stock, and American Depositary Shares trade on exchanges and trade “over-the-counter” as well.

Question 4

Which of the following securities are generally traded “Over-the Counter”?

I Treasury issues
II Municipal issues
III Corporate debt issues
IV Options

A. I only
B. II and III only
C. I, II, III
D. II, III, IV

Answer 4

The best answer is C.

All trades in Treasury issues and municipal bonds are effected “over-the-counter.” The vast majority of corporate debt also trades “OTC,” with the exception of a small amount of bond trading performed on the NYSE. All options trades are effected on exchanges, the CBOE being the largest options exchange. The other exchanges that trade options are the AMEX (American Stock Exchange), PHLX (Philadelphia Stock Exchange), and PSE (Pacific Stock Exchange - now renamed the ARCA exchange).

Question 5

All of the following statements are true about the second market for equity securities EXCEPT:

A. companies that are traded must meet listing standards
B. FINRA regulates the over-the-counter market
C. a greater number of companies trade over-the-counter than trade on any single exchange
D. the over-the-counter market is a negotiated market

Answer 5

The best answer is A.

The over-the-counter market is a negotiated market. A greater number of companies trade OTC (about 6,000 smaller companies) than on any single exchange. For example, the NASDAQ Stock Market has about 3,000 issues; while the NYSE lists about 2,800 issues. OTC equities are quoted in either the OTCBB or the Pink OTC Market. These “quotations vendors” have no listing standards. In contrast, each exchange has its own listing standards. FINRA regulates the OTC market.

Question 6

Registered representatives:

I can trade securities on stock exchange floors
II cannot trade securities on stock exchange floors
III can trade securities over-the-counter
IV cannot trade securities over-the-counter

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 6

The best answer is D.

Registered representatives cannot trade securities - they can enter orders on behalf of customers to be executed by traders in the market.

Question 7

When comparing Specialists (DMMs) on the NYSE to market makers on NASDAQ, which statements are TRUE?

I The Specialist/DMM is obligated to make a continuous competitive market in the stock
II The Specialist/DMM is not obligated to make a continuous competitive market in the stock
III The market maker is obligated to make a continuous competitive market in the stock
IV The market maker is not obligated to make a continuous competitive market in the stock

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 7

The best answer is B.

Specialists (now renamed DMMs - Designated Market Makers) are obligated, under NYSE rules, to make a continuous competitive market in the assigned stock during the entire trading session. NASDAQ Market Makers, on the other hand, once they have traded the amount that they show in the market at a competitive firm price, are not obligated to renew that quote at the current market. They can renew at a price that is “away” from the current market, thus assuring that they will not have to trade! (Of course, it is in their best interests to actively trade that stock and maintain competitive quotes - that is how NASDAQ market makers maintain a good reputation that attracts future business.)

Question 8

Which of the following will result in a “locked-in” trade?

A. A market order placed for a NASDAQ issue quoted in the NASDAQ System (Single Book)
B. A market order placed for an OTC equity issue quoted in the OTCBB
C. A market order placed for an OTC equity issue quoted in the Pink Sheets
D. All of the above

Answer 8

The best answer is A.

A “locked-in” trade is one in which all of the terms and conditions of the trade are accepted by buyer and seller. Once the trade is executed, last-sale reporting to NASDAQ and reporting to the clearance corporation (NSCC) are done electronically. System trades of NASDAQ stocks are “locked-in” - the NASDAQ System is both an automated quotation and execution system. Anyone who enters a quote or order into the System agrees to accept automated executions. Note that the previous name for the System was Single Book, and this may still show on the exam.

The OTCBB and Pink Sheets are quotation mediums only. There is no automated trading; rather, trades are still negotiated “over-the-phone” or “on-line” and thus, are not locked-in.

Question 9

If a member firm routes a customer market order for a NASDAQ Capital Market issue to NASDAQ’s automated trading system, the order will be sent to:

A. the NASDAQ System (Single Book)
B. Super Display Book
C. Pink Sheets
D. OTCBB

Answer 9

The best answer is A.

The system for automated trading and order maintenance of NASDAQ issues (Global Market and Capital Market stocks) is the NASDAQ Market Center Execution System, or simply the “System.” The previous name was Single Book. Super Display Book is the NYSE’s automated execution system. The Pink Sheets give a listing of the bid and ask prices of certain thinly traded OTC stocks that are not exchange listed. The OTCBB (OTC Bulletin Board) is an electronic system that disseminates real-time quotes for smaller OTC stocks.

Question 10

Which of the following securities can be traded using the NASDAQ Market Center Execution System (Single Book)?

A. NASDAQ Global Market issues
B. NASDAQ Capital Market issues
C. All NASDAQ issues
D. All securities trading in the secondary market

Answer 10

The best answer is C.

The system for automated trading and order maintenance of NASDAQ issues (Global Market and Capital Market stocks) is the NASDAQ Market Center Execution System, or simply, the “System.” The predecessor name was Single Book. OTCBB and Pink Sheet issues, which do not have listing standards, cannot be traded through the System.

Question 11

The “spread” on a NASDAQ stock is the difference between the prices of the:

A. last reported trade and prior trade
B. highest bid and lowest ask
C. opening bid and closing bid
D. representative bid and ask

Answer 11

The best answer is B.

When referring to the market for a stock, the “spread” is the difference between the prices of the best bid and best offer. The best bid price (price at which a dealer is willing to buy from a customer) is the highest bid. The best ask price (price at which a dealer is willing to sell to a customer) is the lowest ask price. A narrow bid-ask spread indicates a competitive market.

Question 12

All of the following statements are true regarding quotes provided on NASDAQ Level II EXCEPT:

A. bid and ask quotes are shown
B. the size of the quote is shown
C. quotes are shown for NYSE listed issues
D. quotes are shown for round lots and mixed lots

Answer 12

The best answer is C.

NASDAQ Level II shows all bid and ask quotes for NASDAQ stocks with the size of the quote. The minimum quote size is 100 shares (1 round lot). Quotes for odd lots (less than 100 shares) can be entered into the system, but are not displayed until there are other odd lot orders at the same price that aggregate to 100 shares or over. A mixed lot is an order that has both a round lot and an odd lot component (such as an order for 143 shares - which is composed of a 100 share round lot and a 43 share odd lot). Just like odd lots, any portion of the order that is less than 100 shares is not displayed until there are other odd lot orders at the same price that aggregate to 100 shares or more.Quotes for NYSE listed issues are not found on NASDAQ - rather they are found on CQS - the Consolidated Quotations Service.

Question 13

Quotes shown in the NASDAQ System (Single Book) are:

I Firm
II Unfirm
III 1-Sided
IV 2-Sided

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 13

The best answer is B.

The NASDAQ System only accepts Firm 2-Sided (Bid and Ask) quotes.

Question 14

Which statements are TRUE regarding the NASDAQ System (Single Book)?

I The System handles trades up to a maximum size of 999,999 shares
II The System handles trades of any size
III The System handles both agency and proprietary orders
IV The System handles customer agency orders only

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 14

The best answer is A.

The automated system for trades of NASDAQ issues is the NASDAQ System (previously called Single Book). It accepts orders up to 999,999 shares. Orders can be split for entry into the system; and can be aggregated and executed as a single order (cheaper than multiple orders) within the system size limit. Both agency and principal transactions can be effected through the System.

Question 15

Which of the following orders can be placed in the NASDAQ System (Single Book)?

I Market order
II Stop order
III Limit order
IV Not Held order

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 15

The best answer is A.

Single Book is the quotation and trading system for all NASDAQ issues - both Global Market and Capital Market. The system accepts market orders, marketable limit orders (a limit order at the current inside price) and limit orders that are away from the market. The system cannot accept orders that require human judgment for execution such as a market-not held order (where a trader uses his or her best judgment decide when to execute to get the best price). Finally, the system does not accept stop orders - the same is true for the NYSE Super Display Book system. Member firms take stop orders into their internal systems and feed them to the appropriate exchange if they are triggered.

Question 16

A market maker enters a quote of $10.50 Bid; $10.75 Ask; with a size of “1 x 1” into the NASDAQ System. If a market order to buy is entered into the system for 500 shares, and this dealer’s quote is matched, the market maker will be obligated to sell:

A. 100 shares at $10.50
B. 100 shares at $10.75
C. 500 shares at $10.50
D. 500 shares at $10.75

Answer 16

The best answer is B.

A market order to buy will be matched, in sequence, against the “Ask” quotes in the system, from lowest to highest. Such a market order “sweeps” the book from low to high price, until it is filled. Because this dealer’s Ask of $10.75 is only for 100 shares, this is the amount that the system will match. It will then move to the next Ask quotes from other dealers, in sequence, until the order is filled for 500 shares

Question 17

A market maker enters a quote of $10.50 Bid; $10.75 Ask; with a size of “1 x 1” into the NASDAQ System. If a market order to sell is entered into the system for 500 shares, and this dealer’s quote is matched, the market maker will be obligated to buy:

A. 100 shares at $10.50
B. 100 shares at $10.75
C. 500 shares at $10.50
D. 500 shares at $10.75

Answer 17

The best answer is A.

A market order to sell will be matched, in sequence, against the “Bid” quotes in the system, from highest to lowest. Such a market order “sweeps” the book from high to low price, until it is filled. Because this dealer’s Bid of $10.50 is only for 100 shares, this is the amount that the system will match. It will then move to the next Bid quotes from other dealers, in sequence, until the order is filled for 500 shares

Question 18

A market maker enters a quote of $31.50 Bid; $32.00 Ask; with a size of “3 x 5” into the NASDAQ System. If a market order to sell is entered into the system for 500 shares, and this dealer’s quote is matched, the market maker will be obligated to buy:

A. 300 shares at $31.50
B. 500 shares at $31.50
C. 300 shares at $32.00
D. 500 shares at $32.00

Answer 18

The best answer is A.

A market order to sell will be matched, in sequence, against the “Bid” quotes in the system, from highest to lowest. Such a market order “sweeps” the book from high to low price, until it is filled. Because this dealer’s Bid of $31.50 is only for 300 shares, this is the amount that the system will match. It will then move to the next Bid quotes from other dealers, in sequence, until the order is filled for 500 shares

Question 19

A market maker enters a quote of $20.50 Bid; $21.00 Ask; with a size of “5 x 5” into the NASDAQ System. If a market order to buy is entered into the system for 1,500 shares, and this dealer’s quote is matched, the market maker will be obligated to sell:

A. 500 shares at $20.50
B. 500 shares at $21.00
C. 1,500 shares at $20.50
D. 1,500 shares at $21.50

Answer 19

The best answer is B.

A market order to buy will be matched, in sequence, against the “Ask” quotes in the system, from lowest to highest. Such a market order “sweeps” the book from low to high price, until it is filled. Because this dealer’s Ask of $21.00 is only for 500 shares, this is the amount that the system will match. It will then move to the next Ask quotes from other dealers, in sequence, until the order is filled for 1,500 shares

Question 20

Which statement is TRUE about the NASDAQ Regular Market trading session?

A. The session starts earlier than the NYSE opening
B. The session ends later than the NYSE closing
C. The session coincides with NYSE trading hours
D. The session starts later than the NYSE opening and closes later than the NYSE closing

Answer 20

The best answer is C.

NASDAQ’s Regular Hours session is from 9:30 AM to 4:00 PM Eastern Time - the same as NYSE hours.

Question 21

Which of the following are entered into OATS?

I Orders to buy NASDAQ issues
II Orders to sell NASDAQ issues
III Orders to buy OTC issues
IV Orders to sell OTC issues

A. I and II only
B. III and IV only
C. II and IV only
D. I, II, III, IV

Answer 21

The best answer is D.

OATS stands for “Order Audit Trail System.” It electronically captures order information for equity securities (no more paper order tickets). OATS records of orders are now required for all U.S. equities markets - NYSE, NYSE American (AMEX), NASDAQ and also for OTCBB and Pink OTC Markets issues.

The “idea” is to give FINRA an electronic order trail of each order from entry to execution to trade reporting and comparison. Since each order is entered independently, both buy and sell orders are entered.

Question 22

The system that compares trades of NASDAQ issues and reports the trades to the Network C Tape is called:

A. ACES
B. OATS
C. ACT
D. ADF

Answer 22

The best answer is C.

The ACT system takes the details of completed trades and reports the trade to the Network C (NASDAQ) Tape; to the contra-party to the trade for comparison; and to the clearing corporation for settlement. ACES is the system that allows NASDAQ Order Entry firms to “pass through” their limit orders to NASDAQ Market Makers for order entry and maintenance in SingleBook (not tested on Series 7). OATS is the Order Audit Trail System - which automates order entry. The ADF is the Alternate Display Facility. It is where ECNs display their quotes if they choose not to link to an exchange for quote display.

Question 23

Trades in NASDAQ stocks must be reported by the:

A. initiating member within 10 seconds of execution
B. executing member within 10 seconds of execution
C. initiating member within 60 seconds of execution
D. executing member within 60 seconds of execution

Answer 23

The best answer is B.

Trades of NASDAQ stocks must be reported by the executing member within 10 seconds of execution to the Network C tape. This is FINRA’s reporting rule for trades of NASDAQ stocks and all OTC equity trades, including OTC trades of NYSE-listed issues (Third Market trades), OTCBB trades and trades of Pink Sheet issues. Note that the NYSE operates under the same rule.

Question 24

Which of the following trades are reported through ACT’s Trade Reporting Facilities (TRFs)?

I NASDAQ Market Center trade of a NASDAQ listed stock
II Super Display Book trade of an NYSE listed issue
III Trade of an NYSE listed issue in the Third Market
IV Trade of a listed option contract on the CBOE

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 24

The best answer is A.

The “TRF” is the Trade Reporting Facility that is operated by the ACT system. Initially, the system was used for NASDAQ only. When NASDAQ became a registered stock exchange in late 2006, separate “TRFs” were created using ACT, which allowed NASDAQ to sell its Network C Tape (each exchange sells its tape, it is a big source of revenue for the exchange). The TRFs run by ACT include:

NASDAQ TRF (reporting trades of NASDAQ stocks to the Network C Tape);
NYSE TRF (reporting Third Market trades of NYSE listed issues to the NYSE Network A Tape. The NYSE feeds the trades that take place on its trading floor to this tape on its own);
ORF (the Over-The-Counter Reporting Facility) which reports trades OTCBB and Pink Sheet issues;
TRACS (Trade Reporting and Compliance Service) which reports trades of NYSE, NYSE American (AMEX) and NASDAQ stocks that take place on ECNs that are not linked into an exchange. TRACS feeds the trade into the appropriate Network A, B or C Tape.
Any trade that takes place on the NYSE (which owns and runs Super Display Book) is reported to the Network A Tape by the NYSE. Options trades occurring on exchanges such as the CBOE are reported through "OPRA" - the Options Price Reporting Authority - which is not covered on Series 7.

Question 25

A NASDAQ security is bid at $30.25 and offered at $30.75. An over-the-counter trader effects a trade at $30.75 and charges a commission of $.50 to the customer. The price that will show on the tape is:

A. $30.25
B. $30.50
C. $30.75
D. $31.25

Answer 25

The best answer is C.

Trade prices that are shown on the tape do not include commissions to customers. This trade was effected at $30.75, and this is the price that will show on the tape.

Question 26

Trades of NASDAQ securities executed on an unlinked ECN are reported by:

A. CAES
B. TRACS
C. ACT
D. TRACE

Answer 26

The best answer is B.

An unlinked ECN is one that is not linked into the NASDAQ System or another exchange, so its quotes are shown in a separate system - the ADF - Alternate Display Facility.

Trades of NASDAQ securities executed by unlinked ECNs are reported through TRACS - the Trade Reporting and Comparison Service.

Trades of NASDAQ securities executed by linked ECNs are reported through the TRF - the Trade Reporting Facility that is part of NASDAQ’s ACT system.

TRACE is the FINRA system for reporting of corporate bond trades.

CAES (Computer Assisted Execution System) is an older system used for Third Market trades.

Question 27

Dark Pools are:

I regulated as broker-dealers
II regulated as exchanges
III subject to Regulation ATS
IV not subject to Regulation ATS

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 27

The best answer is A.

An evolution of the ECN is the “dark pool.” Dark pools are operated by the larger broker-dealers (e.g., Goldman Sachs) and there are some that are independent companies (e.g., Liquidnet). They allow institutions to buy or sell very large blocks without displaying their orders in the ADF or in a display system such as the NASDAQ System. They are called dark pools because the size of the trade and the identity of the institution are not displayed. This avoids the problem that could occur where the display of a very large order in such a system, by itself, could move the market. If there is a match in a dark pool and a trade results, it still must be reported to the appropriate tape.

The SEC wrote Regulation ATS (Alternative Trading System) in the year 2000, specifically to address the growth of ECNs, including dark pools. Regulation ATS requires Alternative Trading Systems, which include ECNs, member firm internal crossing systems and dark pools, to register with the SEC and be regulated as broker-dealers (as opposed to registering as an exchange and being regulated as such).

Question 28

Dark Pools:

I display their quotes with size
II do not display their quotes with size
III are obligated to report completed trades to the tape
IV are not obligated to report completed trades to the tape

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 28

The best answer is C.

An evolution of the ECN is the “dark pool.” Dark pools are operated by the larger broker-dealers (e.g., Goldman Sachs) and there are some that are independent companies (e.g., Liquidnet). They allow institutions to buy or sell very large blocks without displaying their orders in the ADF or in a display system such as the NASDAQ System. They are called dark pools because the size of the trade and the identity of the institution are not displayed. This avoids the problem that could occur where the display of a very large order in such a system, by itself, could move the market. If there is a match in a dark pool and a trade results, it still must be reported to the appropriate tape.

Question 29

Dark Pools are:

I sources of displayed liquidity
II sources of undisplayed liquidity
III regulated
IV unregulated

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 29

The best answer is C.

An evolution of the ECN is the “dark pool.” Dark pools are operated by the larger broker-dealers (e.g., Goldman Sachs) and there are some that are independent companies (e.g., Liquidnet). They allow institutions to buy or sell very large blocks without displaying their orders in the ADF or in a display system such as the NASDAQ System. They are called dark pools because the size of the trade and the identity of the institution are not displayed. This avoids the problem that could occur where the display of a very large order in such a system, by itself, could move the market. If there is a match in a dark pool and a trade results, it still must be reported to the appropriate tape.

The SEC wrote Regulation ATS (Alternative Trading System) in the year 2000, specifically to address the growth of ECNs, including dark pools. Regulation ATS requires Alternative Trading Systems, which include ECNs, member firm internal crossing systems and dark pools, to register with the SEC and be regulated as broker-dealers (as opposed to registering as an exchange and being regulated as such).

Question 30

The OTCBB includes quotes for:

I NASDAQ Global Market stocks
II NASDAQ Capital Market stocks
III Non-NASDAQ issues

A. I only
B. II only
C. III only
D. I, II, III

Answer 30

The best answer is C.

Over-the-counter stocks that are too small for NASDAQ are found on the OTCBB - the “Over-The-Counter Bulletin Board” (run by FINRA) or can be found in the privately run “Pink Sheets” - now renamed the Pink OTC Markets.

Question 31

Bid and Ask quotes for non-NASDAQ “over-the-counter” stocks can be obtained from the:

I Pink Sheets
II Yellow Sheets
III OTC Bulletin Board
IV Consolidated Quotations Service

A. I and II only
B. I and III only
C. II and IV only
D. I, III and IV

Answer 31

The best answer is B.

The Pink Sheets give bid and ask quotes for over-the-counter stocks that are not included on NASDAQ. FINRA has the “Non-NASDAQ OTC Bulletin Board,” which gives electronic quotes for stocks that do not meet NASDAQ listing standards. When NASDAQ became a “stock exchange” in late 2006, it did not want the OTCBB, which went to FINRA.

The OTCBB originally had about 6,000 listings - but FINRA did nothing with it, while the Pink Sheets moved to the web and included a trade negotiation system in its software that the OTCBB does not have. Because of this, most of these quotes have moved to Pink OTC Markets, leaving the OTCBB with about 300 quoted issues.

The Yellow Sheets, now out of business, used to provide quotes for corporate bonds traded OTC. The Consolidated Quotations Service (CQS) provides bid and ask quotes for Exchange listed stocks.

Question 32

The Pink Sheets:

I give bid and ask quotes for OTC stocks
II give bid and ask quotes for NASDAQ stocks
III show completed trades as they occur
IV do not show completed trades as they occur

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 32

The best answer is B.

The Pink Sheets give bid and ask quotes for over-the-counter stocks that do not meet exchange listing standards. They do not show trades as they occur. All trade reporting for OTC equity securities occurs through the ORF - the Over-The-Counter Reporting Facility.

Question 33

A dealer offering an OTC stock in the Pink Sheets publishes a quote for 1,000 shares “AON” This means that the dealer:

A. is willing to sell part or all of the shares at the stated price
B. will only sell all of the shares at the stated price
C. does not own the shares being offered and is “interpositioning” in this transaction
D. is willing to sell more than 1,000 shares for a higher price than the published quote

Answer 33

The best answer is B.

A quote that is published as “AON” means All or None. The dealer will sell all of the securities at that price, but will not accept a partial order at that price.

Question 34

Last sale information is available for:

I Exchange listed securities
II Over-the-counter securities
III Municipal securities
IV Over-the-counter Pink Sheet securities

A. I only
B. I and II only
C. II and IV only
D. I, II, III, IV

Answer 34

The best answer is D.

Real time transaction reporting occurs for all exchange trades and for OTC equity trades (OTCBB, and Pink Sheet) trades. Corporate and agency bond trades are reported via TRACE, while municipal bond trades are reported via RTRS.

Question 35

Over-the counter traders perform all of the following functions EXCEPT:

A. establish spreads
B. take positions
C. give quotes
D. perform clerical duties

Answer 35

The best answer is D.

OTC traders position trade (that is, trade for the firm’s inventory account), establish spreads (the difference between the bid and ask quote that is the profit for the dealer), and give quotes to customers. Clerical duties are handled by clerks.

Question 36

Which statements are TRUE about nominal quotes?

I A nominal quote represents an actual price at which the dealer is willing to buy or sell
II A nominal quote represents an approximation of market value, at which the dealer is not obligated to buy or sell
III Nominal quotes must be identified as such when given
IV No identification of a nominal quote is required when given

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 36

The best answer is C.

In the OTC market, it is assumed that quotes, when given, are “firm” - that is the dealer is willing to trade the stated amount at the price given. There is no identification given for a firm quote. A nominal quote given by a dealer is simply an approximation of the current market value of the security, with no obligation of the dealer to trade at that quote. These are atypical, and FINRA requires that nominal quotes be identified as such when given

Question 37

Which of the following is a “firm” quote from a market maker?

A. 12.50
B. 12.50 workout
C. 12.50 subject
D. 12.50 nominal

Answer 37

The best answer is A.

An OTC quote is considered to be “firm” for 100 shares unless it is otherwise qualified. If a dealer gives a quote of 12 - 12.50, he is willing to sell 100 shares at 12.50 or buy 100 shares at 12. A workout quote is an approximate price - the final price must be “worked out.” A subject quote is subject to confirmation. A nominal quote is a “guess” at a likely price - it is really no quote.

Question 38

When a dealer says “The price is 42.25,” the quote is considered a:

A. nominal quote
B. workout quote
C. firm quote
D. subject quote

Answer 38

The best answer is C.

When a dealer says “the price is,” the quote is firm for a normal trading unit at the stated price. A nominal quote is a dealer’s guess at the current price - he or she is not committed to trading at that quote. A “work-out” quote is sometimes given for very thinly traded issues, where there is no current trading in the issue, but the trader believes that the trade can be executed in a given price range. After giving the “work out” quote, the trader will search the market to “work out” the trade within the stated price range. A subject quote is subject to confirmation and can change - it is very close to a nominal quote.

Question 39

In an over-the-counter agency trade, the member firm executing the order:

I is a broker
II is a dealer
III charges a mark-up
IV charges a commission

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 39

The best answer is B.

In an over-the-counter agency transaction, the firm acts as a broker, matching a customer who wishes to buy with a seller (and vice-versa). For this service, the member firm earns a commission. In contrast, in an over-the-counter principal transaction, the member firm sells a security out of its inventory to a customer who wishes to buy; or buys a security into its inventory from a customer who wishes to sell. In this transaction, the firm acts as a dealer, and marks-up the stock to the customer who wishes to buy; or marks-down the stock from the customer that wishes to sell.

Question 40

All of the following terms are synonymous EXCEPT:

A. principal
B. market maker
C. dealer
D. agent

Answer 40

The best answer is D.

A dealer is a market maker, who is a principal in a transaction, earning a mark-up or mark-down. An agent is a broker who is middleman in a transaction, earning a commission.

Question 41

Which statements are TRUE about over-the-counter transactions?

I In a principal transaction, the customer is charged a mark-up or mark-down
II In an agency transaction, the customer is charged a commission
III In a principal transaction, the firm trades from its inventory account
IV In an agency transaction, the firm trades with other market makers

A. I and II only
B. III and IV only
C. I and IV only
D. I, II, III, IV

Answer 41

The best answer is D.

In a principal transaction, a firm trades into, or out of, its inventory account, charging the customer a mark-up or mark-down that is fair and reasonable. In an agency transaction, the firm trades with another market marker, charging the customer a fair and reasonable commission for finding the best market.

Question 42

Broker-dealers are permitted to execute the following over-the-counter transactions?

I Agency trades where the customer is charged a commission
II Agency trades where the customer is charged a mark-up or mark-down
III Principal trades where the customer is charged a commission
IV Principal trades where the customer is charged a mark-up or mark-down

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 42

The best answer is B.

In over-the-counter transactions, for effecting an agency trade, only a commission can be charged; while in a principal transaction, only a mark-up or mark-down can be charged. It is prohibited to charge a commission in a principal transaction. Similarly, it is prohibited to charge a mark-up in an agency transaction. Furthermore, it is prohibited to charge both a commission; and a mark-up or mark-down; in any transaction.

Question 43

Which of the following describes a position trade?

A. Buying a security into inventory directly from a customer with a mark-down
B. After receiving a buy order from a customer, the dealer then purchases the stock into inventory and resells it to the customer
C. Simultaneously buying and selling short the same or equivalent security
D. Selling stock at the direction of a customer and using the proceeds to buy another stock for that customer

Answer 43

The best answer is A.

Position trading is trading for a firm’s own account. This is either selling a security out of inventory direct to a customer with a mark-up; or buying a security into inventory direct from a customer with a mark-down. When the firm “position trades,” the firm can take both long and short positions as it speculates in the market. Choice B describes a “riskless principal” transaction; Choice C describes an “arbitrage transaction;” and Choice D describes a “proceeds transaction.”

Question 44

Which of the following describes position trading?

A. Selling a security for a customer and using the proceeds to purchase a different security for that customer
B. Selling a security from inventory to a customer with a mark-up
C. Buying and selling short the same security simultaneously in different markets to lock in a price differential
D. After receiving a buy order, a dealer purchases the stock into inventory and resells it to a customer

Answer 44

The best answer is B.

Selling a security out of inventory direct to a customer with a mark-up; or buying a security into inventory direct from a customer with a mark-down; is position trading. The term position trading comes from the dealer taking “positions” for his inventory. Choice A describes a “proceeds transaction;” Choice C describes an “arbitrage transaction;” and Choice D describes a “riskless principal” transaction.

Question 45

Position trading by “over-the-counter” firms is:

I buying securities into, or selling securities from, the firm’s inventory account
II buying customer positions from, or selling customer positions to, other market markers
III permitted under FINRA rules
IV a prohibited practice under FINRA rules

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 45

The best answer is A.

Position trading is the buying of securities into a dealer’s inventory account; and the selling of securities out of the dealer’s inventory account. The profit to the dealer is the spread between the bid and ask quote. This is the basic function of an over-the-counter market maker; and is, of course, permitted under FINRA rules.

Question 46

When a firm “position trades,” it:

I trades on an agency basis for customers
II trades on a dealer basis for its own account
III takes inventory positions, both long and short
IV interpositions itself between a customer and another dealer

A. I and II only
B. II and III only
C. IV only
D. II, III, IV

Answer 46

The best answer is B.

Position trading is trading for a firm’s own account. The firm can take both long and short positions as it speculates in the market. Interpositioning is a prohibited practice under FINRA rules. If a customer wishes to buy or sell, a firm is obligated to go directly to the market maker. It cannot interposition another firm (another middleman) between the customer and the best available market.

Question 47

An OTC equity trader has received a large influx of sell orders for ABC stock and, to fill them, has taken an extremely large long position in the firm’s inventory account. The dealer would most likely:

A. decrease the ask price in the OTCBB
B. decrease the bid price in the OTCBB
C. decrease the mark-down to customers that sell
D. place an “OW” in the OTCBB

Answer 47

The best answer is B.

The dealer’s Bid price is too high - that is why the sellers are pouring in! The dealer will lower the Bid price - this will discourage sellers.

If the dealer were to decrease the Ask price, this would encourage sellers to the dealer - and this dealer does not need to buy any more of the stock, he already has an overly large long position.

Decreasing the mark-down charged to customers would encourage more sellers at the Bid, which the dealer does not want, because the dealer does not want to buy any more stock.

Placing an “OW” in the OTCBB is an “Offers Wanted.” This indicates that the dealer wants to buy more of the stock from any willing sellers, which is not the case - the dealer wants to sell the stock, not buy it! Rather, the dealer would want to place a “BW” - Bids Wanted - in the OTCBB, telling potential buyers that he or she is interested in selling.

Question 48

An OTC equity trader has received a large influx of buy orders for ABC stock and, to fill them, has taken a short position in the firm’s inventory account. The dealer would most likely:

A. increase the ask price in the OTCBB
B. decrease the bid price in the OTCBB
C. decrease the mark-up to customers that buy
D. place a “BW” in the OTCBB

Answer 48

The best answer is A.

The dealer’s Ask price is too low - that is why the buyers are pouring in! The dealer will raise the Ask price - this will discourage buyers.

If the dealer were to decrease the Bid price, this would discourage sellers to the dealer - and this dealer needs to buy to cover the current short inventory position. Therefore, the dealer is likely to increase the bid price as well.

Decreasing the mark-up charged to customers would encourage more buyers at the Ask, which the dealer does not want.

Placing a “BW” in the OTCBB is a “Bids Wanted.” This indicates that the dealer wants to sell more of the stock to any willing buyers, which is not the case - the dealer wants to buy the stock, not sell it! Rather, he or she would want to place an “OW” - Offers Wanted - in the OTCBB, telling potential sellers that the dealer is interested in buying.

Question 49

An agency cross transaction performed in the over-the-counter market occurs when a broker-dealer:

A. buys stock on one exchange and sells it on another for an immediate profit
B. receives an unsolicited order to buy stock
C. receives a sell order from a customer and the customer instructs that the proceeds be used to buy another stock
D. receives a buy order from one customer and a sell order from another customer on the same stock and matches the orders

Answer 49

The best answer is D.

An agency cross transaction, as performed in the “over-the-counter” market occurs when, at the same time, a broker-dealer receives an order to buy a stock from one customer; and receives another order to sell the same amount of that stock from another customer. The firm is permitted to “cross” those orders at the current market price.

Under FINRA rules, such transactions must comply with the 5% Policy. In this transaction, the firm is acting as an agent (since it is not buying or selling the securities from its inventory) and may only charge a commission on each side of the trade. These commissions must be “fair and reasonable” under the 5% Policy. Remember, 5% commissions (in agency trades) or mark-ups (in principal trades) are only “guidelines” - not rules. Each commission or mark-up must be “fair and reasonable,” taking into consideration all relevant factors surrounding that transaction.

Question 50

Which of the following describes a riskless principal or simultaneous transaction?

A. Selling a security and using the proceeds to purchase a different security
B. Buying a security into inventory direct from a customer with a mark-down
C. Buying and simultaneously selling short the same security in different markets to lock in a price differential
D. After receiving a buy order, the dealer purchases the stock into inventory and resells it to a customer

Answer 50

The best answer is D.

A riskless principal or simultaneous transaction occurs when a dealer receives a buy order from a customer and then purchases the stock into inventory and resells it to the customer. The dealer wasn’t holding the security when the order was received, so there is no “risk” to the dealer of falling prices giving the dealer an inventory loss. Choice A describes a “proceeds” transaction; Choice B describes a “principal” transaction; and Choice C describes an “arbitrage” transaction.

Question 51

In riskless principal transaction, the dealer:

I buys a security into inventory in advance of filling a customer order to buy that security
II buys a security into inventory after receiving a customer order to buy that security
III charges a mark-up to the customer
IV does not charge a mark-up to the customer

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 51

The best answer is C.

A riskless principal or simultaneous transaction occurs when a dealer receives a buy order from a customer and then purchases the stock into inventory and resells it to the customer. The dealer wasn’t holding the security when the order was received, so there is no “risk” to the dealer of falling prices giving the dealer an inventory loss. The dealer has no risk in the transaction and the mark-up charged must be disclosed to each customer.

Question 52

In a riskless principal transaction, the dealer:

I has risk
II has no risk
III earns a mark-up
IV does not earn a mark-up

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 52

The best answer is C.

In a riskless principal or simultaneous transaction, a dealer gets an order from a customer to buy a security, and then the dealer buys the stock into his inventory to sell to the customer. The dealer has no risk in the transaction and the mark-up charged must be disclosed to each customer.

Question 53

Proceeds transactions are:

I matching a buy order from one customer to a sell order for the same security from another customer
II selling a security for a customer, and buying another security for the same customer
III permitted under FINRA rules
IV prohibited under FINRA rules

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 53

The best answer is C.

In a proceeds transaction, a customer directs that the firm sell a position owned by the customer, and use the “proceeds” to buy another position. In effect, the firm is performing 2 trades for the customer. Choice I describes an agency cross transaction. Both of these types of transactions are permitted under FINRA rules.

Question 54

Which of the following describes an arbitrage transaction?

A. Selling a security and using the proceeds to purchase a different security
B. Buying a security into inventory direct from a customer with a mark-down
C. Buying and selling short the same security in different markets to lock in a price differential
D. After receiving a buy order, the dealer purchases the stock into inventory and resells it to a customer

Answer 54

The best answer is C.

If a security is bought on one market; and simultaneously sold on another market; this is known as an arbitrage transaction and is used to exploit price differences for the same security that may exist in those markets. Choice A describes a “proceeds transaction;” Choice B describes a “principal” transaction, or “position” trade; while Choice D describes a riskless principal transaction.

Question 55

All of the following can result in the establishment of a short position EXCEPT:

A. Arbitrage transaction
B. Sale of a security “against the box”
C. Position trades of borrowed shares
D. Selling a long position

Answer 55

The best answer is D.

Short positions are established in arbitrage transactions (the simultaneous purchase and short sale of a security in two different markets to lock in a temporary price difference). A short position is taken when a security is sold “against the box” - meaning that the long position is being held and an equivalent number of shares are being borrowed and sold to lock in a profit. Finally, position trades of borrowed shares are short sales. Selling a long position is just selling a position that was originally purchased. The purchased shares are delivered to satisfy the sale - there is no borrowing of shares.

Question 56

Which of the following can result in the establishment of a short position?

I Arbitrage transaction
II Sale of a security “against the box”
III Position trades of borrowed shares

A. I only
B. I and III
C. II and III
D. I, II, III

Answer 56

The best answer is D.

Short positions are established in arbitrage transactions (the simultaneous purchase and short sale of a security in two different markets to lock in a temporary price difference). A short position is taken when a security is sold “against the box” - meaning that the long position is being held and an equivalent number of shares are being borrowed and sold to lock in a profit. Finally, position trades (position trading is trading for the firm account, using the firm’s “positions”) of borrowed shares are short sales.

Question 57

A customer has previously entered an order to sell 100 shares of ABCD at $9.50. The quotations terminal shows the last trade of ABCD taking place at $9.50 yet the customer’s order has not been executed. Which are valid reasons for this?

I The trade at $9.50 was performed by another market maker
II There were other limit orders at the same price ahead of the customer’s order
III The trading department has closed for lunch
IV The firm sold the stock for its own account at $9.50 ahead of the customer’s order

A. I and II
B. II and III
C. I and IV
D. I, II, III, IV

Answer 57

The best answer is A.

The customer’s limit order to sell at $9.50 might not be executed even though the last trade occurred at $9.50 because there were other limit orders ahead of his order or another market maker performed a trade at that price. Trading departments must stay open at all times during the hours that the market is open. Firms are prohibited from executing orders for their own account if they compete with an existing customer order. Before the firm can sell for itself at $9.50, it must first sell for the customer at $9.50. Once the customer orders are cleared, the firm can trade at that price.

Question 58

An index arbitrage trading desk places sequential buy orders at the market opening for securities included in the index to raise their price against the current index value. Which statement is TRUE?

A. These transactions can only be effected on an upbid
B. This is an illegal practice known as Marking To Market
C. This is an illegal practice known as Marking The Open
D. This is an illegal practice known as Painting The Tape

Answer 58

The best answer is C.

Marking The Open is trading at the open, or falsely reporting trades at the open, just to affect the stock’s opening price. FINRA has disciplined program traders for “marking the open” violations. These firms attempt to arbitrage the difference between an index option’s value (which can be based on market open, depending on the index option) against the actual prices of the securities that are included in the index. The illegal practice was placing sequential orders at the open for the securities in the index to either move their price up (or down), so that the index arbitrage position would show a profit.