Trading Markets Basics Flashcards
person who makes a secondary market in securities is called a(n):
A. market maker
B. registered representative
C. underwriter
D. retail broker
The best answer is A.
The secondary market is the trading of issues outstanding in the market. The individuals making the secondary market are the market makers (dealers). Market makers deal with the public through registered representatives (retail brokers). Underwriters are the market makers in the primary market (new issues), not the secondary market.
A market maker that compensates a retail member firm for sending its customer orders to that market maker is:
I paying for order flow
II interpositioning
III engaging in a prohibited practice under SEC rules
IV permitted to do so, subject to best execution requirements
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
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.
All of the following statements are true if a customer places an order for an NYSE listed issue EXCEPT the order:
A. must be directed by the member firm to the NYSE trading floor for execution if the customer so requests
B. can be directed by the member firm to any trading venue if the customer does not direct the order to a specific market
C. can be matched internally by the member firm and is not required to be sent to a public trading venue
D. can be directed by the member firm to a trading venue that “pays for order flow” as long as this is disclosed to the customer
The best answer is C.
FINRA member firms cannot match orders internally and cannot “privatize” their trades. All trades must be effected in a public venue - whether it be on the NYSE floor; in the Third Market; or through an ECN. Member firms are permitted to accept payment for order flow, but this must be disclosed to customers. Also remember that any trade price must be the “best” one available at that moment in the public markets.
Customers who trade NYSE listed securities during extended trading hours are:
I subject to a higher degree of price volatility than during regular trading hours
II subject to a lower degree of price volatility than during regular trading hours
III always able to obtain an execution at the market because the Specialist/DMM maintains a continuous auction market
IV not always able to obtain an execution at the market because there is no Specialist/DMM maintaining a continuous auction market
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
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, few dealers participate in the market. Thus, one may not be able to get an execution; and each trade that is executed can result in a much greater than normal market price movement.
The SEC regulation that requires market centers to accept automated executions that do not discriminate against any class of users of their systems is:
A. Regulation NMS
B. Regulation ATS
C. Regulation SHO
D. Regulation M
The best answer is A.
Rule 610 of Regulation NMS requires all market centers to electronically link and provide automated execution within 1 second for orders that are executable. It also mandates that market centers cannot discriminate against customers who access their quotes.
The “trade-through” rule of Regulation NMS:
A. prohibits an order from being routed to a market that will pay for the order
B. prohibits a market maker on an exchange from executing a trade at an inferior price to that posted by another market at that moment
C. requires member firms to execute any order received within 1 second of execution
D. requires member firms to use automated clearing and settlement of all trades
The best answer is B.
The trade-through rule of Regulation NMS requires that any “fast market” (NYSE, AMEX (now renamed the NYSE American) and NASDAQ) must either execute a trade within 1 second at the best price posted for a given security at that moment; or must route that order to the market that is posting the better price (this could be a Third Market Maker or an ECN). Thus, market makers are prohibited from “trading through” another market’s better priced quote.
The “Trade-Through” rule of Regulation NMS applies to all of the following EXCEPT:
A. NYSE issues
B. NYSE American (AMEX) issues
C. NASDAQ issues
D. OTCBB issues
The best answer is D.
Rule 611 of Regulation NMS (National Market System) prohibits an exchange from “trading through” the better priced quote of another market (including Third Market Makers and ECNs). Thus, all exchanges must be linked so that the trade execution will always occur at the NBBO (National Best Bid and Offer prices). If another market is posting a better priced quote, the exchange that receives the order must fill the order at the better price, or must route the order to that market for a fill.
Regulation NMS applies to NYSE, NYSE American (AMEX), and NASDAQ listed issues. These are all markets that can electronically update and access quotes for trade execution within 1 second of order receipt. The rule does not apply to OTCBB or Pink Sheet issues, where the markets are much less liquid and trades are still done manually.
Rule 605 of Regulation NMS requires:
A. each market center to prepare monthly electronic reports about its quality of executions and effective spreads
B. each broker-dealer to prepare quarterly reports on its routing of non-directed orders, including the 10 largest venues where orders were routed
C. market makers in OTC stocks to display any customer limit orders that are better-priced than the dealer’s own quote
D. any order execution facility to execute the order at the NBBO, even if that execution facility is posting an inferior quote
The best answer is A.
Rule 605 of Regulation NMS (“National Market System”) requires market centers to make monthly electronic reports about the quality of execution in each stock traded, including how market orders of various sizes are executed relative to public quotes. The reports must also include information about effective spreads. In addition, market centers must provide reports on the extent to which they were able to “improve” execution prices for limit orders as compared to the public quote at that time.
Do not confuse Rule 605 with Rule 606. Rule 605 covers the quality of trade executions by exchanges; Rule 606 covers broker-dealers and how they routed their orders to exchanges for execution.
Under SEC Rule 606 of Regulation NMS, the required quarterly report on order routing methods includes information on which of the following?
I Directed orders for listed equity securities
II Non-directed orders for listed equity securities
III Directed orders for NASDAQ securities
IV Non-directed orders for NASDAQ securities
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
SEC Rule 606 of Regulation NMS requires broker-dealers to do the following:
The fact that the firm received a payment for order flow must be disclosed on the customer trade confirmation.
The firm, on request of the customer, must disclose the identity of the market to which the customer’s orders were routed for execution in the preceding 6 months along with the time of execution. (These are known as “non-directed” orders, since the customer did not tell the broker the specific market where the order was to be executed, so the member firm could route the order to wherever it wanted.)
The firm must notify customers, in writing, at least annually, of the availability of this information.
In addition, the rule requires member firms to prepare a quarterly report that is publicly available that details the:
Percentage of customer orders that were “non-directed;”
Identity of the 10 largest markets or market makers, to whom non-directed orders were routed and any other venue that received 5% or more of the firm’s orders;
Member firm’s relationship with that market maker (for example, many larger retail member firms own their own market maker subsidiaries to whom they route orders); and
Arrangement, if any, for payment for order flow or profit-sharing.
Because of this rule, member firms cannot have “hidden” arrangements with market makers to favor them in return for “payment for order flow” - everything is out in the open and is fully disclosed. Thus, customers can make informed decisions about how retail member firms are routing and executing their orders.
Note that Rule 606 does not apply to “directed orders” where the customer specified the market venue to which the order was sent.
The rule applies to “non-directed” orders for exchange listed stocks and exchange listed options and NASDAQ securities. It does not apply to executions of trades of OTCBB or Pink Sheet stocks.
An NMS stock is quoted at $30.50 Bid; $35.75 Ask. Which quotes can be accepted by an SRO for this stock?
I $30.55 Bid
II $30.555 Bid
III $30.65 Ask
IV $30.655 Ask
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.
Rule 612 of Regulation NMS does not allow sub-penny quotes or orders to be entered for NMS stocks.
An NMS stock is currently quoted at $15.20 Bid - $15.40 Ask. A customer wishes to place a limit order to buy 100 shares of the stock at $15.211. The registered representative should:
A. reject the order
B. route the order to an Alternative Trading System
C. route the order to an exchange
D. accept the order and round the price to $15.21
The best answer is A.
Rule 612 of Regulation NMS does not allow sub-penny orders to be entered for NMS stocks. The order must be refused under SEC rules (or the representative can tell the customer to enter it as $15.21, but this is not given as a choice).
Which statements are TRUE?
I Orders and quotes for NMS stocks can only be accepted or posted in penny increments in exchange display books
II Orders and quotes for NMS stocks can be accepted or posted in sub-penny increments in exchange display books
III Trade executions of NMS stocks can only occur in penny increments
IV Trade executions of NMS stocks can occur in sub-penny increments
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
Rule 612 of Regulation NMS does not allow sub-penny orders to be entered for NMS (NYSE, NYSE American (AMEX) or NASDAQ) stocks. However, trade executions are permitted in sub-penny increments, since this makes the market more competitive.
An NMS stock is current quoted at $16.10 Bid - $16.30 Ask. A customer wishes to place an order to buy 1,000 shares of the stock at $16.111. The registered representative should:
A. refuse to accept the order
B. route the order to an ATS
C. route the order to an exchange
D. accept the order and round the price to $16.11
The best answer is A.
Rule 612 of Regulation NMS does not allow sub-penny orders to be entered for NMS stocks. The order must be refused under SEC rules (or the representative can tell the customer to enter it as $16.11, but this is not given as a choice).
An institutional customer places a marketable order to buy 10,000 shares of ABCD stock, a NASDAQ listed company. The customer directs that the trade be routed to an ECN for execution and not be sent to the NASDAQ. Which statement is TRUE about this?
A. The customer’s instructions are to be followed and the order must be sent to the designated ECN
B. The order must be sent to the NASDAQ for execution
C. The order must be sent to the market with the largest display size
D. The order cannot be accepted from the customer
The best answer is A.
If the customer directs that the trade be sent to a different trading venue, follow the customer’s instructions. When the ECN gets the order, it must either fill the order at the best price available in all markets; or it must re-route the order to the better-priced market (the “trade-through” rule); so the customer will get the best price, no matter where the order is actually sent!
A technical analyst has been charting the price movements of ABC stock. The stock has been fluctuating in price between $49 and $54 per share for the past 3 months. If the analyst expects a breakout through the support level, which order should be placed?
A. Sell (Short) ABC @ $48 GTC
B. Sell (Short) ABC @ $48 Stop GTC
C. Sell (Short) ABC @ $55 GTC
D. Sell (Short) ABC @ $55 Stop GTC
The best answer is B.
If a stock moves through a support level, it is breaking out on the downside. In this example, the support level is at $49. If the stock moves through this price, it is expected that it will move sharply downward. To sell below the current market, a sell stop order must be used. Therefore, the order to sell (short) ABC @ $48 Stop GTC is appropriate. This would be a short sale (the sale of borrowed shares), so that these shares could be purchased at a lower price after the market drops and used to cover the short position at a profit. A sell limit order cannot be used, since these are orders to sell higher than the current market.
