Trading Market Basics

Question 1

Which of the following is NOT part of the Secondary Market?

A. First Market
B. Primary Market
C. Second Market
D. Third Market

Answer 1

The best answer is B.

The Primary Market is the sale of new issues for the first time; no trading takes place in the Primary Market.

The First Market is trading of exchange listed securities on that exchange floor.

The Second Market is trading of securities that are not exchange listed in the over-the-counter market.

The Third Market is trading of exchange listed securities in the over the counter market.

Question 2

The Secondary Market is divided into how many submarkets?

A. 2
B. 3
C. 4
D. 5

Answer 2

The best answer is C.

The Secondary Market is divided into 4 subcategories: the First Market; the Second Market; Third Market; and the Fourth Market.

The First Market is trading of exchange listed securities on that stock exchange.

The Second Market is trading of securities that are not exchange listed on the over the counter market.

The Third Market is trading of exchange listed securities over the counter.

The Fourth Market is trading of securities directly between institutions in the over the counter market via ECNs (Electronic Communications networks) such as Instinet.

Question 3

The First Market is trading of:

A. listed securities on an exchange
B. OTCBB securities “over-the-counter”
C. listed securities “over-the-counter”
D. securities directly between institutions

Answer 3

The best answer is A.

The First Market is trading of listed stocks on an organized stock exchange - like the NYSE, AMEX (now renamed the “NYSE American”), or NASDAQ. Exchanges have listing standards for the companies that trade there and accessible order books, where orders can be posted and traded against.

Any companies that do not meet exchange listing standards are quoted in either the OTCBB (Over The Counter Bulletin Board) or the Pink OTC Markets. These constitute the Second Market. Both the OTCBB and Pink OTC Markets are classified by the SEC as “quotations vendors” - they are not exchanges. To trade an OTCBB or Pink OTC Markets stock, the trade must be negotiated, usually over the phone.

Choice C describes the Third Market and Choice D describes the Fourth Market.

Question 4

Which first market does NOT trade stocks?

A. NYSE
B. AMEX (NYSE American)
C. PHLX
D. CBOT

Answer 4

The best answer is D.

The NYSE trades stocks. The AMEX and PHLX trade stocks and stock options. (The AMEX is a wholly owned subsidiary of the NYSE, and it has renamed its equities market “NYSE American,” while its options market is still called the AMEX.) The CBOT - Chicago Board of Trade - is not a securities exchange. Rather, it is a futures market.

Question 5

Quotes from all market centers in NYSE listed securities are found on (the):

A. CQS (Consolidated Quotations Service)
B. UQDF (UTP Quote Data Feed)
C. ADF (Alternate Display Facility)
D. Pink Sheets

Answer 5

The best answer is A.

CQS (Consolidated Quotations Service) aggregates and displays quotes for all market makers in exchange listed issues - both NYSE and NYSE American (AMEX) listed. These market makers are exchange Specialists (DMMs) and Third Market Makers (OTC firms that make markets in exchange listed issues).

The UQDF (UTP Quote Data Feed) aggregates and displays quotes for all market makers in NASDAQ issues. UTP stands for “Unlisted Trading Privileges.” Not only do NASDAQ Market makers quote and trade NASDAQ stocks, but exchange Specialists/DMMs are now permitted to compete and trade NASDAQ stocks under a “UTP” plan. The ADF is where ECN quotes are found (Fourth Market). The Pink Sheets (Pink OTC Markets) give quotes for stocks that do not meet exchange listing standards - most of these are “penny stocks.”

Question 6

The best answer is A.

CQS (Consolidated Quotations Service) aggregates and displays quotes for all market makers in exchange listed issues - both NYSE and NYSE American (AMEX) listed. These market makers are exchange Specialists (DMMs) and Third Market Makers (OTC firms that make markets in exchange listed issues).

The UQDF (UTP Quote Data Feed) aggregates and displays quotes for all market makers in NASDAQ issues. UTP stands for “Unlisted Trading Privileges.” Not only do NASDAQ Market makers quote and trade NASDAQ stocks, but exchange Specialists/DMMs are now permitted to compete and trade NASDAQ stocks under a “UTP” plan. The ADF is where ECN quotes are found (Fourth Market). The Pink Sheets (Pink OTC Markets) give quotes for stocks that do not meet exchange listing standards - most of these are “penny stocks.”

Answer 6

The best answer is A.

The Network A Tape reports trades of NYSE-listed issues, regardless of the market venue where the trade took place.

The Network B Tape reports trades of NYSE American (AMEX) and regional exchange-listed issues, regardless of the market venue where the trade took place.

Reports of trades of NASDAQ issues are made through the Network C Tape, regardless of the market venue where the trade took place.

There is no Network D Tape.

Question 7

All of the following are trades that take place in the Second Market EXCEPT trades of:

A. OTCBB securities
B. Municipal bonds
C. U.S. Government bonds
D. NYSE listed securities on the exchange floor

Answer 7

The best answer is D.

The Second Market is OTC (over-the-counter) trading of securities that are not listed on an exchange. For equities, the Second Market is the OTCBB (Over-The-Counter Bulletin Board) and the Pink OTC Markets. Also, virtually the entire debt market is “OTC” - including the Treasury market, municipal bond market, and the corporate bond market (only a tiny amount of corporate bonds are traded on exchanges).

NYSE-listed issues traded on the exchange floor represents the First Market.

Question 8

The Second Market is the:

A. trading of OTCBB stocks
B. issuance of listed stocks
C. trading of listed stocks on the floor of an exchange
D. issuance of listed and unlisted stocks

Answer 8

The best answer is A.

The Second Market is over-the-counter trading of securities that are not listed on a stock exchange. For equities, the Second Market is the OTCBB (Over-The-Counter Bulletin Board) and the Pink OTC Markets.

The First Market is trading of listed stocks on an exchange.

Choices B and D are definitions of the primary (new issue) market - not the secondary (trading) markets.

Question 9

The trading of listed securities over-the-counter occurs in the:

A. First Market
B. Second Market
C. Third Market
D. Primary Market

Answer 9

The best answer is C.

The trading markets are:

First Market: Trading of exchange listed securities on stock exchanges
Second Market: Trading of unlisted securities over-the-counter
Third Market: Trading of exchange listed securities over-the-counter
The Primary Market is where new issues are sold (not traded).

Question 10

The “Third Market” is trading of:

A. listed securities over-the-counter
B. listed securities on stock exchanges
C. unlisted securities over-the-counter
D. unlisted securities solely on regional stock exchanges

Answer 10

The best answer is A.

The trading markets are:

First Market: Trading of exchange listed securities on stock exchanges
Second Market: Trading of unlisted securities over-the-counter
Third Market:
Trading of exchange listed securities over-the-counter

Third Market Makers are OTC firms such as Jefferies and Co. and Weeden and Co. that stay open 24 hours a day and capture much of their trading volume in NYSE-listed issues when the NYSE is closed.

Question 11

The Fourth Market is direct trading of securities between:

A. brokers buying for their own accounts
B. NYSE customers
C. NASDAQ customers
D. institutions

Answer 11

The best answer is D.

The Fourth Market is direct trading of securities between institutions on ECNs (Electronic Communications Networks) such as Instinet or Archipelago. The systems bypass brokerage firms, and therefore brokerage commissions. Instead, the ECN charges a small matching fee.

Question 12

ECNs trade securities

A. during regular NYSE market hours
B. between 9:00 AM and 9:00 PM
C. 24 hours a day
D. only when the primary trading markets are closed

Answer 12

The best answer is C.

ECNs - Electronic Communications Networks - only accept orders for actively traded securities - that is, NYSE listed and NASDAQ stocks. Essentially they are electronic matching services, matching customer buy and sell orders for a very low fee (often as low as $1 per trade). ECNs do a lot of their volume when the major exchanges are closed - since these venues stay open 24 hours a day.

Question 13

Which of the following securities is NOT traded in the secondary market?

A. Preferred Stocks
B. American Depositary Receipts
C. Mutual Funds
D. Municipal Bonds

Answer 13

The best answer is C.

Equities - common stock, preferred stock, and American Depositary Receipts trade on exchanges and are traded “over-the-counter.” Municipal and U.S. Government bonds are traded “over-the-counter.” There is no trading of mutual fund shares - these are redeemable securities that are redeemable with the sponsor.

Question 14

All of the following securities are traded in the secondary market EXCEPT:

A. corporate stocks
B. corporate bonds
C. municipal bonds
D. mutual funds

Answer 14

The best answer is D.

There is no trading of mutual funds - these securities are not tradable - rather, they are issued by the fund and redeemed with the fund. Corporate stocks exchanges and “over-the-counter.” Most corporate bonds trade OTC, with a tiny amount traded on the NYSE. Municipal bonds are only traded “over-the-counter.”

Question 15

High trading volume and narrow bid/ask spreads would be characteristic of a(n):

A. consolidated market
B. efficient market
C. inefficient market
D. centralized market

Answer 15

The best answer is B.

Efficient markets are characterized by high trading volumes and narrow bid /ask spreads.

Question 16

The Second Market is a(n):

A. auction market
B. negotiated market
C. unregulated market
D. primary market

Answer 16

The best answer is B.

The Second Market is trading of unlisted securities “over-the-counter.” This is a negotiated market. For example, a stock quoted in the OTCBB is actually traded by picking up the phone, calling the market maker posting the quote, and negotiating a price.

Question 17

The trading of securities on regional stock exchanges is most similar to trading, as it takes place, on the:

A. NYSE
B. CBOE
C. NASDAQ
D. MSRB

Answer 17

The best answer is A.

The regional stock exchanges use a Specialist (Designated Market Maker) system for trading similar to the NYSE.

NASDAQ uses a system of competing market makers, instead of a single Specialist/DMM in each security.

The CBOE uses a system similar to that of the Chicago Board of Trade, where the Specialist market maker function is handled by a Market Maker; while the Specialist book function is handled by an Order Book Official (OBO).

The MSRB does not trade municipal securities. Trading of municipal securities is conducted over-the-counter and is supervised by FINRA (FINRA audits broker-dealers for compliance with MSRB rules).

Note: The regional exchanges as independent entities are a dying breed. At the end of 2007, NASDAQ purchased the PHLX and the Boston stock exchanges. The NYSE has purchased the Pacific and American stock exchanges and has renamed the Pacific as the “ARCA” exchange and the American as the “NYSE American.” These must still be known for the exam, since these are being run as separate subsidiaries of the major markets.

Question 18

A dual listed stock is one which trades in two different:

A. countries
B. U.S. markets
C. cities
D. states

Answer 18

The best answer is B.

A dual listed stock is one which trades in more than one marketplace - for example, a young West Coast company might have listed on the Pacific exchange when it was still small; and then listed on the NYSE when the company became large enough. Finally, note that most companies are only listed on 1 major market because each exchange charges listing fees, and corporations see no reason to pay multiple listing fees.

Question 19

Stocks that are listed on the New York Stock Exchange can also be typically listed and traded on all of the following exchanges EXCEPT:

A. American Stock Exchange
B. Chicago (Midwest) Stock Exchange
C. Boston Exchange
D. Pacific Exchange

Answer 19

The best answer is A.

Stocks that are listed on the NYSE are typically NOT listed on the AMEX (now renamed the NYSE American) or NASDAQ. Each one of these is a “national” stock exchange, trading companies where there is a “national interest” in trading those stocks. A dual listed stock is one which trades in more than one marketplace, and the typical example is a company that listed on a regional exchange when it was small, and then grew large enough to list on a national exchange.

For example, a young New England company might have listed on the Boston exchange when it was still small; and then listed on the NYSE when it became large enough; and it kept its Boston exchange listing to maintain its New England “ties.”

Question 20

The individuals who make a secondary market in corporate bonds include all of the following EXCEPT:

A. Market Makers
B. Traders
C. Underwriters
D. Dealers

Answer 20

The best answer is C.

The secondary market is the trading of issues outstanding in the market. The individuals making the secondary market are the market makers (also known as dealers) and traders.

Underwriters take new issues public in the primary market (new issues), not the secondary (trading) market. Once these issues are placed by the underwriter, they start trading in the secondary market.

Question 21

Which statement is TRUE?

A. A securities dealer will buy stock at the bid price and sell stock at the ask price
B. A securities dealer will sell stock at the bid price and buy stock at the ask price
C. A securities dealer will buy stock and sell stock at the midpoint between the bid and ask price
D. A securities dealer will buy and sell stock at the price of the last reported trade

Answer 21

The best answer is A.

Securities dealers quote stocks with a bid and ask. The bid is the price at which the dealer is willing to buy from the customer (therefore, the customer is selling to the dealer at the bid). The ask is the price at which the dealer is willing to sell to the customer (therefore, the customer is buying from the dealer at the ask).

Question 22

A securities dealer is quoting ABCD stock at 12.00 - 13.00 (10 x 15). This means that the dealer is willing to:

A. buy 1,000 shares at $12 and sell 1,500 shares at $13
B. sell 1,000 shares at $12 and buy 1,500 shares at $13
C. buy 1,200 shares at $10 and sell 1,300 shares at $15
D. sell 1,200 shares at $10 and buy 1,300 shares at $15

Answer 22

The best answer is A.

Securities dealers quote stocks with a bid and ask. The bid is the price at which the dealer is willing to buy from the customer (therefore, the customer is selling to the dealer at the bid). The ask is the price at which the dealer is willing to sell to the customer (therefore, the customer is buying from the dealer at the ask).

Within the brackets is the “size” of the quote - how many shares the quote is good for. This dealer is willing to buy 1,000 shares at $12 and is willing to sell 1,500 shares at $13. The “size” is 10 x 15 is denoted in round lots of 100 shares- this translates into 1,000 shares bid at $12 and 1,500 shares offered at $13 by the dealer.

Question 23

A securities dealer is quoting ABCD stock at 10.00 - 11.00 (15 x 20). This means that the dealer is willing to:

A. buy 1,500 shares at $10 and sell 2,000 shares at $11
B. sell 1,500 shares at $10 and buy 2,000 shares at $11
C. buy 1,000 shares at $15 and sell 1,100 shares at $20
D. sell 1,000 shares at $15 and buy 1,100 shares at $20

Answer 23

The best answer is A.

Securities dealers quote stocks with a bid and ask. The bid is the price at which the dealer is willing to buy from the customer (therefore, the customer is selling to the dealer at the bid). The ask is the price at which the dealer is willing to sell to the customer (therefore, the customer is buying from the dealer at the ask).

Within the brackets is the “size” of the quote - how many shares the quote is good for. This dealer is willing to buy 1,500 shares at $10 and is willing to sell 2,000 shares at $11. The “size” is 15 x 20 is denoted in round lots of 100 shares- this translates into 1,500 shares bid at $10 and 2,000 shares offered at $11 by the dealer.

Question 24

A securities firm does a trade for a customer and charges a mark-up. In what capacity did the firm act?

A. Agent
B. Dealer
C. Broker
D. Middleman

Answer 24

The best answer is B.

A FINRA member firm can do securities transactions in one of two ways. It can act as a broker, routing the order to the best market, charging a commission for this service. This is called an agency trade, and the firm is acting as a middleman in the transaction.

The other way to do the trade is to act as a dealer. Here, the firm maintains an inventory of the security, and acts as a principal, buying the security into inventory from the customer; or selling to the customer out of inventory. When acting as a principal, the firm earns a mark-up when selling to the customer out of inventory; or a mark-down when buying into inventory.

Also note that the firm can only act in one capacity in a given transaction – either as a broker or as a dealer. Thus, it could not charge both a commission and a mark-up in the same transaction.

Question 25

A market maker that compensates a retail member firm for sending its customer orders to that market maker is:

A. paying for order flow
B. interpositioning
C. engaging in a prohibited practice under SEC rules
D. front-running

Answer 25

The best answer is A.

If a retail member firm chooses a market maker to execute its orders in return for compensation from that market maker, then the retail firm is earning so-called “payment for order flow.” The SEC permits this practice, subject to the retail member firm always executing its trades at the best available price.

Question 26

An order for a New York Stock Exchange listed issue is routed by the member firm to an Electronic Communications Network (ECN) rather than to the exchange floor. This practice is permitted:

A. if the price offered by the ECN is better
B. only if the customer consents
C. only if an attempt to fill the order on the NYSE fails
D. only if the NYSE is closed

Answer 26

The best answer is A.

SEC rules require that execution must occur at the “best market.” If a stock is traded in multiple markets, then the order must be routed by the member firm to the market that is posting the best quote

Question 27

The “after hours” trading market for exchange listed and NASDAQ securities:

A. is a more liquid market than the regular hours trading session
B. is all transacted at the issue’s closing price in the regular session.
C. typically has wider dealer bid-ask spreads than regular trading sessions
D. typically has higher dealer participation than regular trading sessions

Answer 27

The best answer is C.

The “after hours” trading sessions have much lower investor participation, so trading volumes are very small. Because of the lack of order flow, the market is less liquid; and as a result, dealers who make the market demand wider bid-ask spreads.