Securities Markets, oriented

Start with capacity, because the exam and the statute both hang on it. The Act defines a broker as a person "engaged in the business of effecting transactions in securities for the account of others", and a dealer as one buying and selling "for such person's own account". A single broker-dealer does both, switching capacity trade by trade. It acts as agent when it arranges your purchase for a commission, and as principal when it sells you stock from its own inventory at a markup. The common misconception is that these are two kinds of company. They are two roles, and the role decides how the firm is paid and what it owes you.

Above the firms sit self-regulatory organizations: a national securities exchange, a registered securities association, or a registered clearing agency, with the Municipal Securities Rulemaking Board included for limited purposes. So the industry has rule-writers who are not the government. They are not free agents, though. An SRO must file any proposed rule change with the Commission, with a concise statement of its basis and purpose, and the Commission publishes notice of it. Self-regulation means industry drafting under federal approval, never industry deciding alone.

The consequence people miss is enforcement reach. An SRO can censure, suspend or expel its own members, because membership is what it controls. It cannot imprison anyone. Suppose you, as a registered representative, forged a client signature: the association could bar you, the Commission could pursue civil remedies, and a criminal case would be a separate matter in a different forum.

Rule: before answering any regulator question, name the capacity and the body. Whose account was the trade for, and does the rule you are reciting come from a statute, a Commission rule, or an SRO rulebook?

The primary market is where the issuer receives the money. Everything after that is the secondary market. Fix this early, because "secondary offering" and "secondary market" are different ideas.

The Securities Act rules turn registration into a sequence. Before filing, the issuer is quiet. After filing and before effectiveness, a prospectus carrying substantially the required information may be used: the preliminary, or red-herring, prospectus. That is why a syndicate collects indications of interest, not sales, in that window. After effectiveness, sales and confirmations are permitted. Effectiveness is not automatic either: the registrant and the managing underwriters can request acceleration to a date they name.

Two rules explain otherwise-puzzling behavior. A shelf registration registers securities now for an offering made on a continuous or delayed basis later, so a seasoned issuer can sell into a good week without starting over. A tombstone advertisement is defined negatively: certain communications limited to specified statements are not a prospectus, which is why those announcements read like legal notices. Dealers also carry a prospectus-delivery obligation after the offering, for a period the rules fix by reference to the Act.

Suppose your client calls during the waiting period wanting to buy. You may send the preliminary prospectus and record an indication of interest. You may not accept payment or confirm a sale until the registration statement is effective. The trap is reading the effective date as approval. Clearance to sell is not endorsement; the government never vouches for the investment.

Rule: for any primary-market question, locate yourself on the clock — filed or not, effective or not — because the permission you are being asked about changes at each boundary.

First, separate what is exempt. A government or municipal issue is an exempt security: the paper itself sits outside registration wherever it goes. A private placement is an exempt transaction: the same shares sold another way would need registration. If you confuse the two, you will give confident wrong answers, because an exempt transaction leaves resale restrictions attached to securities that were never registered.

Regulation D provides the limited-offering exemptions, treating qualifying offers and sales as transactions not involving a public offering. Its two live variants differ on advertising. One prohibits general solicitation and general advertising. The other permits them, but the issuer must take reasonable steps to verify that each purchaser is an accredited investor. The rules name who may supply that verification: a registered broker-dealer, a registered investment adviser, or a licensed attorney in good standing, among others. Consider an issuer that posts an offering on a public website. That act alone forecloses the non-advertising route and commits it to verification.

Regulation A is the middle path. It exempts a public offer or sale of eligible securities from Securities Act registration and splits into Tier 1 and Tier 2 by the aggregate offering price. Rule 144 addresses the other end: when a holder reselling restricted or control securities is not deemed to be engaged in a distribution, and therefore not an underwriter.

Because exempt offerings skip registration, they skip its disclosure too. Illiquidity and thin information are features of the route, not accidents.

Rule: ask which exemption is claimed and what it costs the buyer. Every escape from registration removes a protection, and the removed protection is usually the answer.

Once securities trade among investors, the rules shift from disclosure to execution. The order-protection rule requires a trading center to enforce written policies reasonably designed to prevent trade-throughs of protected quotations. The definition is exact: a trade-through is buying an NMS stock during regular hours below a protected bid, or selling above a protected offer. The national best bid and offer is the best bid and offer calculated and disseminated on a current and continuing basis. So the promise is narrow but real: your order should not execute at a worse price than one publicly displayed and protected elsewhere.

Not every venue you trade on is an exchange. An alternative trading system is defined functionally: it brings together purchasers and sellers, or otherwise performs the functions of a stock exchange, without registering as one. That is how dark pools and electronic networks sit inside the regulated structure rather than outside it.

Short selling has its own machinery. Before a short sale, the broker-dealer must have borrowed the security, arranged to borrow it, or have reasonable grounds to believe it can be borrowed by the delivery date. It must document that compliance. If a fail-to-deliver position persists at a clearing agency for thirteen consecutive settlement days, the participant must close it out by buying securities of like kind and quantity. Suppose a hard-to-borrow stock spikes. The locate is what stopped a sale made on hope, and the close-out is what ends the fail.

Rule: for any trading question, ask what the rule protects — the displayed price, the delivery, or the venue's status — because each has its own remedy.

The most useful distinction here is who owns the lever. Monetary policy is the central bank's action toward the dual mandate Congress specified: maximum employment and stable prices. Fiscal policy, taxing and spending, belongs to Congress. Many questions that look like economics only test whether you know which body did the thing described.

The Federal Reserve's structure follows from that. The Board of Governors is an independent federal agency; the Reserve Banks are the operating arms, supervised by the Board. The Federal Open Market Committee sets national monetary policy with twelve voting members: the seven governors, the president of the New York Reserve Bank, and four of the remaining eleven Reserve Bank presidents on one-year rotating terms.

The common mistake is imagining one official who sets the rate. Take the discount rate: each Reserve Bank recommends the rate for its own discount window, and the Board reviews and determines it. The federal funds target is a committee decision. No single seat sets policy, which is exactly what the structure was built to prevent.

Implementation is where dated study material misleads you. Open market operations are purchases and sales of US government securities. But the framework now relies on administered rates, chiefly the interest paid on reserve balances, with a standing overnight reverse repurchase facility that puts a floor under the federal funds rate. If your textbook describes policy as draining scarce reserves, it describes an older regime.

The names for the numbers stay stable: gross domestic product for output, the consumer price index for prices, the unemployment rate for labor slack, with a core measure stripping volatile components.

Rule: identify the actor before the effect. If Congress did it, it is fiscal; if the committee did it, it is monetary — and check whether the mechanism described is the current one.

The municipal market has its own rulebook because its issuers are governments, which federal registration largely leaves alone. Administrative rules govern the board itself and definitional rules fix terms. The general rules, the ones you will work under, divide by function into professional qualification, fair practice, uniform practice, market transparency and internal administration.

Two general rules carry most of the weight. The fair-dealing rule sets a broad standard of honest conduct toward everyone a dealer deals with, prohibiting deception and unfair practice. It is broad enough to reach conduct no specific rule anticipated. The best-execution rule obliges a dealer to look for the best market with reasonable diligence, so your customer's price is as good as conditions then allow. A separate suitability rule governs recommendations.

Disclosure runs through the official statement. The issuer or its representatives prepare it, it is complete as of the date delivered to the participating underwriters, and it sets out the terms of the issue and the information material to evaluating it. That definition is why a preliminary version circulates first and the final one arrives at delivery.

The role most often confused is the municipal advisor. It owes fiduciary duties to its municipal entity clients, which makes advising an issuer and underwriting the same issue incompatible. Suppose a school district hires a firm to advise on structuring a bond issue, then invites it to underwrite. The adviser's duty runs to the district, while an underwriter buys from the district, on the other side of the table.

Rule: in a municipal question, ask who owes a duty to the issuer and who is transacting with it. Rulebook contents and thresholds are revised, so check the edition you are studying.

Each statement answers a different question, and the exam preys on treating them as one. The balance sheet shows assets, liabilities and shareholders' equity at the end of a period, and it balances by construction: assets equal liabilities plus shareholders' equity. It is a snapshot with no flows. Assets are ordered by how quickly they become cash, with current assets expected to convert within a year, and liabilities by when they come due.

The income statement covers a span and works like a staircase. Start at gross revenue, subtract returns and allowances for net revenue, cost of sales for gross profit, then operating expenses and depreciation for income from operations. Interest and tax take you to the bottom line. Earnings per share divides net income by shares outstanding.

The cash flow statement reorders the other two into operating, investing and financing activities, ending in the net change in cash. Here the profit-versus-cash misconception dies. Net income is adjusted for non-cash items such as depreciation, so a profitable company whose customers have not paid can still be starved of cash.

Ratios are derived, not disclosed. Working capital is current assets minus current liabilities. Operating margin is income from operations over net revenues: the share of each sales dollar that was profit. The price-earnings ratio is price per share over earnings per share; a share at forty-five dollars earning three dollars a share trades at fifteen times earnings. Debt-to-equity divides total liabilities by shareholders' equity, so one and a half means a dollar fifty of borrowing behind every dollar the owners contributed.

Rule: name the question before the formula. Position, performance or cash — the statement you need follows from which one you are being asked.

Allocation and diversification are related but not the same, so get that straight first. Allocation divides a portfolio among categories such as stocks, bonds and cash. Diversification spreads money among different investments to reduce risk, limiting losses without giving up too much potential gain.

The inputs are personal rather than predictive. Time horizon is how long until the money is needed. Risk tolerance is the willingness and ability to lose some of the original investment for greater potential return. The categories behave differently by design. Stocks have historically carried the greatest risk and the highest returns, and large-company stocks as a group have lost money in roughly one year in three. Bonds are generally less volatile with more modest returns, though high-yield bonds carry stock-like risk. Cash equivalents are the safest and lowest-returning, and their main danger is inflation eroding the return.

Rebalancing is where discipline shows: you bring the portfolio back to its original mix after growth pulls it out of line. Suppose a portfolio was set at half stocks and half bonds, and two strong years leave stocks at seventy percent. Restoring the target means selling some stock, directing new money to the underweighted side, or altering future contributions until the weights come back. The misconception is that rebalancing chases performance. It does the opposite, trimming what has run and buying what has lagged. You can schedule it on the calendar, every six or twelve months, or trigger it when a category's weight moves beyond a band chosen in advance.

Rule: decide the mix from your horizon and tolerance, write it down, and let the written mix — not the recent return — tell you when to trade.