Order types and execution

Question 1

What is the primary market?

Answer 1

Also known as new issue market, is a source of new securities. The main bulk of the money from the sales goes to the issuer with some going to the broker. This market is broken into three categories

Question 2

What are the three categories of the primary market?

Answer 2

IPO - Initial public offering is the first time a company sells stock (first primary offering), this is also known as going public.

Primary Offering - Is the first or subsequent sales of new shares. For ex: companies can be authorized to sell 100,000 in shares, their IPO can be 80,000 (also considered a first time primary offering), let’s say in two years they need more money, they can offer another primary offering of the last 20,000 shares.

Combined (split offering) - a combination of primary offering shares and outstanding shares (shares that have been owned and are being sold)

Question 3

What is the Secondary market?

Answer 3

This is where the outstanding shares (shares owned by an investor and not the issuer) are traded. This is also known as the aftermarket. There are 3 categories.

Question 4

What are the three categories of the secondary market?

Answer 4

Secondary Market - Outstanding securities trading on an exchange like NYSE or NASDAQ

Third Market - Also known as OTC where prices are negotiated without a central location for trading.
□ Any securities that trade in the secondary market can trade in the third.

Fourth Market - This is where institutions trade using the ECNs (electronic communication network) without the use of a broker.

Question 5

What is an exchange?

Answer 5

An auction market, where bidders and sellers got to trade.

Question 6

What are features of exchanges?

Answer 6

○ All have a trading floor where the trades are executed
○ Each security listed has a post (where the security is traded) on the floor
○ Brokers make hand signals or shout to let the other know what they’re willing to pay for a security.
○ Sellers shout the price they’re willing to sell a security for
○ If buyers and sellers come to an agreement, a trade happens

Question 7

What is the main Exchange?

Answer 7

Main exchange is the NYSE, also known as the Big Board or Exchange

Question 8

What are the other exchanges?

Answer 8

○ Other exchanges include the NYSE AMEX Equities (formerly the American stock exchange)
NASDAQ
Chicago Board options exchange (CBOE)
Boston stock Exchange (formerly BSE now NASDAQ OMX BX)

Question 9

What trades exclusively on the OTC?

Answer 9

Municipal and US treasury bonds only trade on OTCBB

Question 10

Who operates the OTC?

Answer 10

OTCBB is operated by FINRA

Question 11

Where do corporations trade if they are too small to trade on the market or OTC?

Answer 11

Corps too smol to be placed on OTCBB May still trade under the pink sheets
Pink sheets securities are exempt from SEC registration

Question 12

Does the OTC have Market Makers?

Answer 12

OTC does NOT have market makers, instead they have firm (dealers) that can be market makers with FINRAs approval.

Question 13

What is an Inside market?

Answer 13

OTC market makers create the inside market, a market that is made by the highest bid and lowest ask price.

The firms that make the inside market have round lots which are limits to what they’re looking to buy/sell, like 5x10.

Each number represents 100 shares

Question 14

What is the role of a broker dealer ?

Answer 14

○ Broker-Dealer - Buys and sells securities for its own account and acts as the middleman for the customer for trades not associated w the broker dealers accounts

Question 15

What is a Broker?

Answer 15

An individual or firm that does not use its own inventory when trading, instead they act as the middle man between the customer and what they want to trade.

Brokers are also known as agents or stockbroker.
Brokers may charge a commission for facilitating a trade.

Question 16

What is a Dealer?

Answer 16

An individual or firm that buys and sells out of its own inventory. Dealers buy securities in hopes they appreciate.

	§ Dealers charge a markup when selling securities to a client (sales fee)
	§ Dealer charges a markdown when buying securities from a client 
	§ Also known as principal, market maker, and dealer.

Question 17

What is Capacity?

Answer 17

Capacity refers to whether a firm was acting as a broker (agent) or dealer (principal)
And must always be disclosed on the confirmation.

If broker - commission must be disclosed
If dealer - they may disclose markup/down

Question 18

What is an Introducing broker ?

Answer 18

Someone who does not actually execute the trade, they provide advice and hand the trade over to a clearing broker

Question 19

What is a Clearing Broker?

Answer 19

(clearing firms) handle client orders (buy, sell)

They also maintain custody of the clients securities and cash (assets)
CB are responsible for segregation (separating the cash and securities) in a clients account

Question 20

What is a Prime Broker

Answer 20

Offer more complex services that other brokers don’t, such as lending, cash management, and leveraged trade execution.

Prime brokers are used by institutional or large retail clients.

Question 21

Order types - Market order (Buy/Sell)

Answer 21

Immediate order set to execute at the best available price.

Buy - investor executes at the lowest ask price, they are bullish and hope after the sale the value increases.
Sell - an investor sells at the highest bid price

Question 22

What does a narrow-spread mean?

Answer 22

The narrower the spread (bud-ask) the more traded a security is

Question 23

What is a short sale and what is the risk?

Answer 23

□ A short seller is someone that sells borrowed shares and then hopes the price drops (bearish) to then buy the shares back cheaper and return to the lender keeping the difference.

Short sell has unlimited loss potential because the price can rise indefinitely. So when it’s time to pay back the shares, you’re forced to buy high

Question 24

What account type must a short sale be done on?

Answer 24

Short sales must always be done on margin accounts.

Question 25

What is regulation SHO

Answer 25

Regulation SHO covers short selling. All order tickets must be marked short sale instead of long sale (long sale is when an investor sells securities, they already own).

Question 26

What is a Stop order? (Buy/Sell)

Answer 26

An order set to execute at a certain price or better. Buy stop order Can be used to hedge short positions. - Ex: An investor can short sell ABC stock at 25 and set a stop order to buy at 30 in case it does not go his way. Sell stop order - Can be used to hedge a long position. EX: if you buy a security for 100 and want to ensure your don’t lose any capital, you can set a stop order at 90 to limit the loss in case it does not go your way.

Question 27

What is a Limit order (Buy/Sell)?

Answer 27

Investors set specific prices in which they want the orders to execute at Limit buyers state they want to pay no more than X (limit)or lower for a security Limit sellers state they want to sell their shares for at least Y (limit) or higher.

Question 28

What is a Stop Limit Order?

Answer 28

A combination of a stop and limit order. It’s a buy stop or sell stop that turns to a limit order once a certain price is reached. Closer to a STOP order because you set a stop price and a limit price. The system will try and buy or sell at the limit price ONCE the STOP PRICE is reached. EX Buy Stop Limit Order - ABC stock is at 76, you set a stop to buy at 80 with a limit of 82, the system will queue up a buy order at the limit (82) once the stop is reached (80) EX Sell Stop Limit Order - XYZ stock is trading at 60, a sell at stop at 55 with a limit of 54, the system will queue up a sell order at the limit of 54 Stop limit orders are price specific and may not be executed if other orders were placed ahead.

Question 29

Basic order functions - Day

Answer 29

good till end of day unless stated otherwise. These orders cancel out after trade date ends

Question 30

Basic order functions - good til canceled

Answer 30

Also known as an open order is an order that is placed to execute until canceled. ex an Good till canceled Buy order. ABC stock can be 35 and bob wants to buy at 30, he places a Limit order that is good till cancelled, it will execute if it ever hits 30 or stay open. Many broker dealers set expiration of these orders for 30-60-90 days because investors forget

Question 31

Basic order functions - Not Held (NH)

Answer 31

An order where the broker can execute at their discretion, the broker picks the timing only if they believe they can get a better price for a customer. Reminder for a broker to pick the timing AND security, shares, buy/sell, the client needs to have opened a discretionary account

Question 32

Basic order functions - Fill or Kill (FOK)

Answer 32

Order to fill an entire order at a limit set or better OR cancel the whole thing.

Question 33

Basic order functions - Immediate or Cancel (IOC)

Answer 33

Similar to FOK orders, these orders may be partially filled before being cancelled.

Question 34

Basic order functions - All or None (AON)

Answer 34

Are orders to be filled completely or not at all, these limit orders can be Day or good till canceled and may have multiple attempts to fill.

Question 35

Basic order functions - At the Open

Answer 35

Are orders to be executed at market or limit at market open. If not filled, they are canceled.

Question 36

Basic order functions - At the close (market close)

Answer 36

Orders set to execute at the closing price (or as close as possible) if not filled they are cancelled.

Question 37

Basic order functions - Do not reduce (DNR)

Answer 37

An order with a set price (stop or limit) to set to execute at that price regardless of ex-dividend date. Ex: If ABC stock is trading at 50 pre ex-dividend date, then a dividend is declared of $1 and the stock goes to 49 on ex-dividend date. The investors DNR order limit or stop price will NOT be reduced.

Question 38

Basic order functions - Alternative

Answer 38

Also known as an either or order. Client sets a Stop price to hedge his investment and a Limit in case it goes the other way, one is fulfilled and the other is cancelled. Ex - Bob owns ABC stock at 60, Bob sets an alternative order of Stop at 55 (sell at 55 if it begins to fall) and a limit at 65 (start selling if it goes up). Only one is fulfilled the other is cancelled.

Question 39

Basic order functions - Bid wanted

Answer 39

Used when no other buyers are available, a bid wanted is an investor telling a broker dealer they are wishing to sell a security.

Question 40

Basic order functions - Offer wanted

Answer 40

used to buy a security when no sellers are available. An investor is telling a broker dealer to look for sellers.

Question 41

What is Reasonable diligence ?

Answer 41

It is our job to ensure we get the best price possible for the client and minimize any fees and commissions.

Question 42

What are ways to ensure a registered representative has done their reasonable diligence?

Answer 42

§ Number of markets checked § The price of the security § Volatility of the security § Liquidity of the security § Size and type of transaction § Number of markets checked § Accessibility of the quotation

Question 43

What is Discretionary vs non-discretionary orders?

Answer 43

Discretionary - Nonspecific where the investor wants your input to fill the reset of the order requirements Discretionary orders require the client give prior written POA approval to the brokerage firm before executing a discretionary order. POA remains in effect until the account is closed or POA is revoked Discretionary orders are marked on the ticket and must be closely regulated by the principal manager Non-discretionary - when the investor tells you exactly what to do. A registered rep can set the timing of an order without it being considered discretionary as long as the client gives all other details and verbal permission to do so.

Question 44

What are Solicited orders vs unsolicited orders?

Answer 44

Solicited - Registered rep calls the client letting them know that something is happening and to place an order ○ Ticket is marked as solicited Unsolicited - Client tells you exactly what to do and when to do it. You don’t go soliciting order (Vanguard) ○ Ticket is marked unsolicited taking you off the hook if the market goes south

Question 45

What is a Retail Investor?

Answer 45

Investors that buy or sell for their own personal accounts

Question 46

What is an Accredited investor?

Answer 46

High dollar sophisticated investors that buy or sell at high dollar amounts or are more knowledgeable than other investors. ○ Banks and other financial institutions ○ Insiders and control personal ○ Government individuals and registered reps ○ Millionaires not including their property ○ Organizations with assets over 5 mil ○ Net income over 200k individual or 300 joint ○ Employees of private equity funds ○ Yes even corporations and organizations with over 5K in assets ○ Rural investment companies ○ LLCs with over 5 mil in assets ○ Ultra high net worth individuals ○ B family businesses w assets over 5 mil

Question 47

What is an Institutional investor?

Answer 47

Big money and knowledgeable about the market ○ Commercial banks ○ Mutual funds ○ Pension Funds ○ Insurance companies ○ Real estate investment trusts ○ Hedge funds ○ Endowment funds

Question 48

Market orders execute at what BID and ASK price?

Answer 48

Highest Bid Lowest Ask