Series 65

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Trading Securities - Account Types


There are three types of brokerage accounts available to investors:

  • Cash accounts - there is no type of credit available in a cash account, so the customer must pay in full for securities that are purchased. Also, only long positions can be sold in a cash account - no short sales are permitted.

  • Margin accounts - with a margin account, an investor can use credit to pay for a percentage of the securities purchased. The brokerage extends the credit and uses the securities as collateral. Interest is charged on the borrowed funds. Investors can buy either long or short positions in a margin account. The Federal Reserve requires a minimum deposit of 50% of the purchase price be deposited in cash or securities before a margin transaction can take place. Broker-dealers can set higher margin requirements.

    Refer to the tutorial, Margin Trading, for more on what margin is, how margin calls work and how leverage can be advantageous.

  • Options accounts - puts and calls can only be traded in an options account. A separate account must be opened for this purpose. A client must provide information about his/her financial situation, investment objectives and previous investment experience before an options account can be opened, since options are not suitable for all clients.

Commissions
There are three types of compensation that a broker-dealer may charge when making securities trades for clients:

  • Commissions - this fee is charged when the broker-dealer is acting as the agent for the client. The size of the commission depends upon the number of shares purchased.

  • Markup - this is the compensation received when a broker-dealer is acting as a principal and sells a security from its own account to a client - the markup is the difference between the market price and the price charged to the client.

  • Markdown - this is the compensation received when a broker-dealer is acting as a principal and buys a security from a client for its own account.


Exam Tips and Tricks
Consider these sample exam questions:

  1. A client has a significant gain in his holdings of ABC stock (a long position) and wants to protect that gain from a drop in the market. The appropriate order to place is:
    1. Market order
    2. Buy stop order
    3. Sell stop order
    4. Sell limit order

The correct answer is "c", since the client would need to sell the stock before the market price falls beneath a certain level. A sell stop would become a market order if the stock reached that price. "d" is not correct, since it would not guarantee execution, and the client would not be protected.

  1. Short sales of stocks may be purchased in what type of account(s)?
    1. Only in cash accounts
    2. Only in options accounts
    3. Only in margin accounts
    4. Either in an options or margin account

The correct answer is "c", since only options may trade in an options account, and securities cannot be borrowed in a cash account.

  1. A market maker in the over-the-counter market must be ready to purchase the security at the:
    1. Bid
    2. Ask
    3. Offer
    4. Spread

The correct answer is "a", since the market maker must sell at the ask price (also known as offer), and the spread is the difference between the two.

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