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Study Guide Chapter 3


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Study Guide Chapter 3

  1. 1. 3 The Marketplace OUTLINE Introduction The Role of the Capital Markets Economic Function Continuous Pricing Function Fair Pricing Function The Exchanges National Exchanges Regional Exchanges Trading Systems The Over-the-Counter Market The National Market System Tiers of the OTC Market Third and Fourth Markets Regulation The Exchanges The SEC The NASD SIPC Ethics Illegal vs. Unethical The Chartered Financial Analyst Program AIMR Standards of Professional Conduct KEY TERMS Ask price Curb exchange Association for Investment Management Dual listing and Research (AIMR) Economic function Bid price Fair pricing function Big Board Fourth market Broker Instinet Bucket trade Listed security Chartered Financial Analyst (CFA) Marketmaker Churning Matched order Circuit breaker National Association of Securities Commission Dealers (NASD) Continuous pricing function National Association of Securities Cross trade Dealers Automated Quotations Crowd (NASDAQ) 19
  2. 2. 20 Chapter 3 National exchange Post National market issue Primary market National Market System Regional exchange NYSE Direct+ Seat Offer price Secondary market Open outcry Securities Act of 1933 Over-the-counter market Securities and Exchange Penny stock Commission (SEC) Pink sheet issues Securities Exchange Act of 1934 Pit Small-cap issue Ponzi scheme Small Order Execution System (SOES) Specialist Spread SuperDot Third market Wash sale TRUE/FALSE QUESTIONS T F 1. Securities markets provide an efficient system allowing borrowers (primarily businesses) to acquire funds from savers (primarily households). T F 2. Without secondary markets, investors would be forced to hold securities until firms liquidated, or until shares were passed on to heirs. T F 3. The primary market functions to supply new capital to the issuing firm. T F 4. The New York Stock Exchange is an example of the primary market. T F 5. Securities markets that have “fair prices” assure investors that their investments will earn high rates of return. T F 6. The Small Order Execution System (SOES) makes it easier for small investors to buy and sell stocks listed on the New York Stock Exchange. T F 7. The Philadelphia Stock Exchange has its prices published every day in The Wall Street Journal and is an example of a national exchange. T F 8. The fourth market is to institutions what selling your own car is to you. T F 9. BY NYSE rules, in order to keep a “fair and orderly” market the specialist is sometimes required to trade against the market trend, even if such trades are likely to result in losses to the specialist. T F 10. Market makers on the NASDAQ system can be forced to trade stock in order to ensure an orderly and fair market. TF 11. Trading curbs halt all trading at an exchange T F 12. “Penny Stocks” would be listed on the pink sheets.
  3. 3. The Marketplace 21 T F 13. A market maker who did not want to “trade,” would list her bid price lower and her ask price higher than other market makers in a particular stock. T F 14. The general public is not allowed to engage in the fourth market. T F 15. The Securities and Exchange Commission is the government agency that makes sure the price on the stock issue is “fair.” T F 16. Trading the customer’s account in excess of market conditions is a condition of churning. T F 17. A “chain letter” which requires you to send money to the person who sent you the letter is an example of a Ponzi scheme. T F 18. All securities analysts in the U.S. must register with the SEC and agree to abide by AIMR’s Standards of Professional Conduct. T F 19. Any illegal securities activity is also unethical. T F 20. SIPC insurance protects investors from loss due to declines in the market value of their investments. MULTIPLE CHOICE QUESTIONS 1. For there to be a market a. it is not necessary for there to be a physical location. b. the market does not necessarily own the goods or services. c. it may deal in any number of goods and services. d. all of the above. 2. Primary security issues are sold a. on national exchanges. b. on regional exchanges. c. in over-the-counter markets. d. all of the above. 3. Secondary market trading of securities occurs a. on national exchanges. b. on regional exchanges. c. in over-the-counter markets. d. all of the above.
  4. 4. 22 Chapter 3 4. Third market trades a. involve trading in listed securities b. execute through the NASDAQ or another OTC market c. offer substantial flexibility of terms to participants d. all of the above. 5. Fourth market trades a. occur on national exchanges. b. occur on regional exchanges. c. occur only through the Internet d. are direct trades between institutional investors 6. A dual listing a. is not allowed by the SEC. b. requires SEC approval. c. occurs only for the top 200, or so, stocks. d. allows regional exchanges to compete with national exchanges. e. reduces the responsibility of the specialist. 7. A “bucket trade” a. is illegal b. does not actually execute at the time it is given to a broker c. is more of a bet than a trade d. all of the above 8. The AIMR Standards of Professional Conduct prohibit a. paying analysts for their opinions b. knowing participation in any violation of the law c. ownership of any stock in which the analyst might express an opinion d. all of the above 9. The AIMR Standards of Professional Conduct prohibit a. disclosure of conflicts of interest b. plagiarism c. fair dealing d. all of the above 10. The SuperDOT is an electronic system that conducts about ___ % of NYSE trades and ___% of NYSE volume. a. 8; 2 b. 80; 20 c. 18; 80 d. 85; 38 11. If the DJIA were to increase by 5% before 1:00 p.m., then a. computerized trading via the SuperDOT system is restricted. b. trading curbs halt all trading on the exchange for one hour. c. trading curbs halt all trading on the exchange for two hours. d. trading curbs halt all trading on the exchange for the remainder of the day.
  5. 5. The Marketplace 23 12. A “$2 broker” is a. an exchange employee. b. a member trading for his/her own account. c. a member executing a trade for a public account. d. a specialist executing a trade for a public account. 13. Which of the following statements about the over-the-counter market is false? a. The privilege of trading in the OTC market is granted by the Securities and Exchange Commission (SEC). b. Only members of NASD are allowed to trade in the OTC market. c. For practical purposes, placing an order in the OTC is as easy as the NYSE. d. In general, firms traded OTC tend to be smaller than NYSE firms. e. Historically, the average risk and return of OTC firms has been greater than NYSE firms. 14. The Securities Act of 1933 a. was the first major piece of national legislation directed specifically toward the securities market. b. requires the prospective issuer of securities to file a registration statement. c. covers large, long-term issues and excludes certain securities. d. all of the above. 15. The Securities Exchange Act of 1934 a. extended federal regulation to the organized exchanges operating in the secondary market. b. established the Securities and Exchange Commission (SEC). c. prohibits insiders from making speculative profits on the shares of the company about which they have inside information. d. all of the above. 16. A “Ponzi scheme” a. is another name for Generally Accepted Accounting Principles (GAAP) b. is a government program that provides retirement and other benefits to U.S. workers c. refers to techniques for finding initial investors in oil and gas exploration ventures d. pays early investors with money taken from later investors 17. The Securities Investor Protection Act a. brought pension funds under federal regulation. b. charged managers with the preservation of capital and to make prudent investments choices. c. Created the SIPC to act as an insurance company against failed broker/dealers. d. gave the SEC the authority to halt trading on an exchange or to restrict practices such as program trading. 18. Investing in securities gives rise to taxable income from a. dividends. b. interest payments. c. capital gains when stocks are sold at a price above their historical cost. d. all of the above. 19. The organization most responsible for setting standards within the professional investment community is the
  6. 6. 24 Chapter 3 a. ABA. b. AIMR. c. CFP. d. CPA. e. Ph.D. 20. An investor can expect a Chartered Financial Analyst to a. charge no more than 10% higher than any other analyst in the marketplace. b. put a minimum guarantee on the results of their work. c. use reasonable care and exercise independent judgment. d. include only facts in reports. e. all of the above. FILL-IN QUESTIONS 1. Initial public offerings (IPOs) are brought to the public in the _____________ market. 2. The over-the-counter market is both a primary and ________________ market. 3. In the over-the-counter market stocks are bought for and sold from the inventories of dealers who are ______________ in those stocks. 4. The American Exchange (AMEX) is also known as the ___________ exchange. 5. The SEC is expected to ensure _______________________________ of relevant corporate information to potential and current investors. 6. The two most important pieces of securities legislation in the U.S. are the ________________________ and the _______________________. 7. In order to attain the Chartered Financial Analyst (CFA) charter, a candidate must pass __________ exams. 8. Under _____________ pricing, prices are available moment by moment during the trading day. 9. The offering price is sometimes referred to as the _________________ price. 10. The price you are able to sell your security is called the ______________ price. INTERNET EXERCISE Go to some of the major sources of public information on stock market the New York Stock Exchange, the American Stock Exchange, and the NASDAQ Stock Market at the following addresses:,, and Compare the contents of these exchanges just to become familiar with them. Click on the international links at the NYSE and NASDAQ and see what's there.
  7. 7. The Marketplace 25 ANSWERS TO TRUE/FALSE QUESTIONS 1. T 2. T 3. T 4. F – the NYSE is part of secondary market trading 5. F – fair prices do not assure investors of achieving high returns 6. F – the SOES is part of the NASDAQ system 7. F – the Philadelphia Exchange is a regional exchange. 8. T 9. T 10. F – NASDAQ market makers do not have such an obligation 11. T 12. T 13. T 14. F - when you sell your stock to anyone outside a broker/dealer, you are in the fourth market. 15. F – the SEC requires full disclosure of relevant information, the investor must determine if the security is attractively priced 16. T 17. T 18. F – some “analyst” positions are exempt from SEC registration and while it would be a good thing if all securities analysts would abide by AIMR’s standards, only members of AIIMR are required to do so as a condition of their continued membership in AIMR 19. T 20. F – the SIPC does not protect investors from making investments that decline in value ANSWERS TO MULTIPLE CHOICE QUESTIONS 1. d 11. a 2. c 12. c 3. d 13. a 4. d 14. d 5. d 15. d 6. d 16. d 7. d 17. c 8. b 18. d 9. b 19. b 10. d 20. c ANSWERS TO FILL-IN QUESTIONS 1. primary 6. Securities Act of 1933 and the Securities Exchange Act of 1934 2. secondary 7. three 3. market makers 8. continuous 4. curb 9. bid 5. full and fair disclosure 10. ask