Securities Markets, the SEC, and the Fed

Question 1

What are preemptive rights?

Answer 1

Current stock owners get dibs on new issuances of stock

Question 2

4 attributes of common stock

Answer 2

1. You have voting rights equivalent to proportional ownership in the company
2. Entitled to dividends (after preferred stockholders)
3. Rights to assets in the event of liquidation of the company (after bond/debt holders and preferred stock)
4. Sometimes,** preemptive rights**

Question 3

5 attributes of preferred stocks

Answer 3

1. No voting rights
2. First dibs on dividends (fixed or participating)
3. Rights to assets in the event of liquidation BEFORE common shareholders (AFTER Bond/debt holders)
4. These stocks are callable (company can choose to redeem the stock)

Question 4

True or False

Corporations get a tax break for investing in common and preferred stock of other companies

Answer 4

True

Question 5

The Internal Revenue Code allows corporate stockholders to exclude __a__% of corporate dividends of another company from taxable income when they own less than __b__% of the other company. If ownership of another company exceeds __c__%, then the percentage amount excluded from income increases raising the exclusion to as much as __d__%.

Answer 5

a. 70%
b. 20%
c. 20%
d. 100%

Question 6

True or False

For corporate investors seeking fixed income, the only option are bonds

Answer 6

False; preferred stocks work too

Question 7

Describe the holding period requirements for qualified dividends

Answer 7

-Stocks must meet other basic requirements

-Then, you must hold the stock over 60 days during 121 day period

-i.e. 60 days BEFORE the dividend execution date (ex-dividend date)

Question 8

Describe the conditions that must be met for qualified dividends (6 things)

Answer 8

1. Dividends must be paid out by US corp or qualified foreign corp.
2. Can’t be capital gains distributions
3. Can’t be dividends paid on deposits by banks/savings & loans
4. Can’t be dividends paid by tax exempt org or farmers cooperative
5. Can’t be paid by employer securities held through employee stock ownership plan
6. Holding period

Question 9

2 types of brokers (explained)

Answer 9

Full Service Broker - provides a variety of services to clients, including advice; high commissions

Discount Brokerage Firms - provides basic trading services, no advice; low commissions

Question 10

What does spread mean?

Answer 10

It’s the difference between the purchase price and sale price of equity

Question 11

Describe the process of purchasing equity securities through brokers

Answer 11

1. You place order online or though the phone
2. Broker decides which market to send it for execution
3. Broker is paid by
   a. 3rd Market Maker (exchange)
   b. Over the counter Market Maker (eg NASDAQ)
   c. Another division in firm (internalization; makes money on spread)

Question 12

3 most basic types of brokerage accounts

Answer 12

1. Cash - just cash for trades
2. Margin - account for trading via loans from brokerage
3. Wrap Accounts - brokerage firm manages portfolio through this account by fee

Question 13

What is Regulation T?

Answer 13

Establishes standards and rules regarding all margin accounts

(Securities Exchange Act 1934)

Question 14

True or False

All 3: Cash, Margin, and Wrap Accounts are governed by rules set forth in Regulation T

Answer 14

False; only cash & margin accounts are subject to Reg T

Question 15

What do you call credit from a brokerage that can be used for trading?

Answer 15

Margin

Question 16

What is initial margin?

Answer 16

The percentage of the purchase price of securities that can be purchased on margin (credit)

Question 17

What do minimum maintenance requirements do with regards to margin accounts?

Answer 17

MMRs dictate what percentage of equity must be maintained in the account (so brokerage firms can protect themselves)

Question 18

What is a Margin call?

Answer 18

If equity falls below minimum maintenance requirement, a margin call is issued and the account holder will need to deposit more cash/securities, sell some securities, etc.

Question 19

The price below which a margin call will occur is (this formula)

Answer 19

initial purchase price x (1-initial margin ÷ 1-maintenance margin)

Question 20

3 basic types of Orders

Answer 20

1. Market
2. Limit
3. Stop

Question 21

How does a Market Order work?

Answer 21

Most common;

Instructs broker to buy/sell securities immediately at the best price available when order reaches trading floor is placed on the OTC market

Price isn’t known until confirmed

Question 22

How does a Limit Order work?

Answer 22

Trying to buy at a price dip

or sell when stock goes up

Question 23

Why use limit orders?

Answer 23

Limit orders can cancel automatically if not filled during a set time. They’re used when an investor wants to open a long position in a stock at a certain price

Question 24

How does a Stop Order work?

Answer 24

Don’t want to miss out so buy a stock when the price starts to go up

Don’t want to take a loss out so sell a stock when the price dips

Question 25

Why use Stop Orders?

Answer 25

A stop order is used by an investor who wants to lock in profits or limit losses by exiting a position

Question 26

SLoBS over BLiSS. What does this mean?

Answer 26

SLoBS (Sell Limit; Buy Stop) orders are meant to be placed above the market price

BLiSS (Buy Limit; Sell Stop) orders are meant to be placed below the market price.

Question 27

True or False

Reg T requires that Margin calls be set at 50%

Answer 27

False; the initial margin call must be no lower than 50%