UNIT 03.01-002 Flashcards
Under the rules governing the activities of broker-dealer firms, prior consent of the employing firm would not be required in order for a registered representative of the firm to
discuss investment strategies with a brother whose account is at another broker-dealer.
Prior written consent from an employing broker-dealer is required for an associated person of the broker-dealer to open an account (cash or margin) at another broker-dealer, or any account in which the associated person has a beneficial interest, such as a spouse.
Discussing investment strategies with a sibling who has an account at another broker-dealer does not require notification or consent of the employing broker-dealer.
Which of the following would suffice to verify the identity of a prospective customer?
Unexpired drivers license
Valid passport
An unexpired drivers license, valid (i.e., unexpired) passport, or certain government employee identification forms is required to establish the identity of a new customer.
Which of the following statements regarding joint accounts is true?
If an account has a joint registration, distributions must be made payable to all parties.
In a joint account, all distributions must be made payable to all parties and all parties can trade in joint accounts; in a TIC account, a deceased party’s assets pass to the decedent’s estate.
Which of the following must be indicated in a customer’s file?
Name
Date of birth
All primary information, such as name, address, Social Security number, and date of birth must be noted immediately in the file. Educational degrees and society memberships are nice to know, not need to know.
A broker-dealer pledging a portion of a customer’s stock as collateral for a loan from a bank to provide funds for margin borrowing is an activity known as
rehypothecation.
HYPOTHECATION is the term for pledging an asset as collateral for a loan.
ECUMBERINGis not a term used in margin borrowing.
REHYPOTHECATION is between a BD and a bank. Leverage is the use of borrowed money to make an investment.
Hypothecation and rehypothecation are both financial practices involving the use of collateral to secure loans, but they differ in their application and implications, especially within the context of the securities industry, which is crucial for the FINRA Series 6 exam. Here’s a comparison:
Hypothecation
- Definition: Hypothecation is the process of pledging securities as collateral to secure a loan without transferring title of the securities to the lender. In the context of securities, this often applies to margin trading, where investors borrow money to buy securities and pledge those securities as collateral for the loan.
- Control of Securities: The borrower retains ownership of the securities, but the securities are controlled by the brokerage or financial institution that lent the money. The securities cannot be sold or transferred without the lender’s consent.
- Risk and Return: The risk for the borrower includes potential margin calls if the value of the collateral falls below a certain level. For the lender, the risk is mitigated by control over the collateral. The return for the lender is the interest on the loan.
- Regulation: The use of hypothecation in securities trading is tightly regulated, with requirements for margin accounts, including minimum margin levels and maintenance margins set by regulatory authorities like FINRA.
Rehypothecation
- Definition: Rehypothecation occurs when a lender (such as a brokerage firm) uses the securities pledged as collateral by the borrower (the client) to secure another loan for its own purposes. Essentially, it’s the reuse of collateral pledged by clients to secure further financing.
- Control of Securities: In rehypothecation, the securities may be moved out of the borrower’s account and used by the brokerage firm for its own transactions, including as collateral for its own loans.
- Risk and Return: This practice introduces additional risk for the original borrower because their assets are being used to secure another party’s borrowing. The risk for the lender/brokerage includes potential market risk and operational risk in managing collateral. The return involves the ability to obtain financing or leverage based on the rehypothecated collateral.
- Regulation: Rehypothecation is also regulated, with limits on the amount of client assets that can be rehypothecated and requirements for disclosure to clients. Regulations vary by jurisdiction, with stricter rules in some countries than others.
Key Differences
- Purpose and Use: Hypothecation is primarily about securing a loan for the borrower using the borrower’s assets as collateral. Rehypothecation takes this a step further by allowing the lender to use the collateral for its own financing needs.
- Control and Ownership: While hypothecation allows the borrower to retain ownership (but not necessarily full control) of the collateral, rehypothecation involves the collateral being potentially used in a way that extends beyond the borrower’s direct control.
- Regulatory and Risk Aspects: Both practices are regulated, but rehypothecation introduces additional layers of risk and complexity, given the collateral is used in further financial transactions beyond the original loan.
Understanding these differences is crucial for financial professionals, especially when preparing for exams like the FINRA Series 6, as they affect how securities are traded, the risks involved in trading on margin, and the regulatory landscape of the securities industry.
Alright, let’s break down the concepts of hypothecation and rehypothecation in a really simple way, as if we’re talking about borrowing a book from a library, but with a financial twist.
Hypothecation: Borrowing with a Promise
Imagine you want to buy a bike but don’t have enough money. So, you go to a bank and say, “Hey, I want to borrow some money to buy a bike.” The bank agrees but asks for a guarantee that you’ll pay back the loan. You offer your new bike as a guarantee. This is like hypothecation. In the financial world, instead of a bike, you’re using stocks or bonds you bought with the borrowed money as a guarantee.
- What it means: You promise the bank (or broker) that if you can’t pay back the money, they can take the bike (or stocks/bonds).
- You still own the bike (or stocks): Even though the bank has a claim on it if you can’t pay.
- It’s like a safety net for the bank: They know they have something valuable if things don’t go as planned.
Rehypothecation: The Bank’s Borrowing with Your Promise
Now, imagine the bank takes your bike and decides to lend it to someone else to use for a while, promising to get it back before you need it. They do this to make a little extra money or for some other benefit. This is what rehypothecation is like. In finance, the bank (or brokerage) uses the stocks or bonds you gave as a guarantee to get a loan for themselves.
- A step further: The bank uses your bike (or your stocks/bonds) to secure its own interests.
- More complicated: Because your bike (or assets) is now tangled up in another deal.
- Risky for you: If the bank messes up, there might be issues getting your bike (or stocks) back in the same condition, or at all.
Key Points
- Ownership vs. Use: In both scenarios, you “own” your bike or stocks, but what can be done with them while they’re used as guarantees changes.
- Safety and Risk: Hypothecation is a way to make a deal safer for the lender. Rehypothecation introduces more moving parts and risks, especially for you, since your property is being used in ways that might be out of your control.
- Rules and Regulations: Just like there are rules for what can be done with borrowed property, there are strict financial regulations to manage how hypothecation and rehypothecation work, aiming to protect everyone involved.
Think of these concepts like a chain of borrowing and promising, where each step needs trust and rules to make sure everyone plays fair and the bike (or your investments) doesn’t end up lost.
Adrian and Alex are tenants in a joint account. If Adrian passes away their share of the account will be distributed through Adrian’s estate. What type of account is this?
Tenants-in-common (TIC)
A TIC account requires that a decedent’s portion of an account be identified and distributed as part of the decedent’s estate. In JTWROS and TBE accounts the decedent’s interest remains in the account and becomes the property of the survivors. A TOD designation only comes into play after the last account holder dies.
Bailey wants to open an account for their unincorporated business, Bailey’s Best Burgers. Bailey is the sole owner of the restaurant. Which of the following registration types would be best for Bailey’s Best Burgers?
Sole proprietor
The sole proprietor account is best given the facts presented. As Bailey’s Best Burger has one owner and is unincorporated, both the corporate and partnership accounts will not work. As the account is for the business it should bear the business’s name, which the individual account would not.
Which of the following is not required on a new account form?
The customer’s signature
It may seem odd, but the regulations do not require a customer’s signature for a new account. Most broker-dealer firms do require a signature as policy, but not the regulators. A principal’s signature accepting the account for the firm is required.
A client and her spouse own shares in the ACE Fund as tenants in common. She has a 60% ownership interest in the account and her spouse has the balance. If the client dies, what happens to the shares in the account?
Forty percent of the shares would belong to her spouse and the remaining balance would be distributed to her estate.
In a TIC account, securities pass to the deceased owner’s estate. Unlike JTWROS, the percentages don’t have to be equal.
An employee of a FINRA member firm wishes to open an account at another member firm. The member firm opening the account
must obtain the employing firm’s permission to open the account.
Persons associated with one FINRA member firm may open securities accounts at other member firms. The firm opening the account must notify the employing firm in writing and receive the employing member’s prior written consent in order to open the account.
