SIE section 1: knowledge of capital markets

Regulators and market participants

The outline starts with who does what. The SEC is the federal regulator created by the Securities Exchange Act of 1934; it oversees the self-regulatory organizations, which write and enforce rules for their members. FINRA supervises broker-dealers, the MSRB writes rules for municipal securities dealers but does not inspect or discipline firms itself, and options exchanges such as Cboe regulate trading on their markets. Around them sit other bodies with narrower roles: the Treasury and the IRS for tax matters, state regulators gathered in NASAA, the Federal Reserve for credit and money, SIPC, which protects customers when a broker-dealer fails, and the FDIC, which insures bank deposits, not securities.

Traps in this block

• SIPC protects against the failure of a firm, not against a fall in market prices.
• The MSRB makes rules; FINRA and bank regulators enforce them for municipal dealers.
• An introducing broker takes orders and sends them to a clearing firm, which holds the money and securities.

Markets and the economy

In the primary market an issuer sells new securities and receives the money; in the secondary market investors trade among themselves and the issuer receives nothing. The economic block asks how forces outside the markets move prices. Monetary policy is the Fed's lever: buying securities in the open market adds reserves and pushes rates down, selling them does the reverse. The discount rate is what the Fed charges banks that borrow from it; the federal funds rate is what banks charge one another overnight. Fiscal policy is the government's lever, through taxes and spending.

The business cycle runs from expansion to peak, contraction and trough. Defensive stocks such as utilities and consumer staples hold up better in a contraction; cyclical stocks such as autos and heavy industry swing with the cycle. Inflation erodes fixed payments, which is why rising inflation tends to hurt bond prices. The calculator under this text shows the gap between a nominal return and a real one: a 6% return with 3% inflation is worth a little less than 3% in purchasing power.

The international angle

Expect a question or two on the balance of payments, GDP versus GNP, and exchange rates. A weaker dollar makes US exports cheaper abroad and raises the dollar value of foreign investments held by Americans; a stronger dollar does the opposite.

How securities are offered

In a firm commitment underwriting, the syndicate buys the whole issue and bears the risk of unsold shares; in a best efforts deal, it acts as agent and returns what it cannot sell. A shelf registration lets an issuer register securities now and sell them in pieces later. The prospectus is the disclosure document for a registered corporate offering; the official statement plays that role for a municipal issue. Some offerings are exempt from SEC registration, such as private placements under Regulation D or intrastate offerings under Rule 147, though state blue-sky laws may still apply. Rule 144 governs resales of restricted and control stock, and Rule 144A resales to large institutions.

Studying section 1

This section is small but nearly all recall, so it pays to learn it early and keep it warm with a mixed practice set each week. Make a one-page map of regulators with a line on what each one does and does not do, since mix-ups between them are the most common errors. The other sections build on this vocabulary: products and their risks, trading and accounts and the regulatory framework.