FIA Equity Markets & Trading 5 — Questions and Answers
Question 1: What does 'Regulation NMS' primarily govern in US equity markets?
- The disclosure requirements for corporate insiders
- Rules ensuring investors receive the best available prices across trading venues (Correct answer)
- The capital requirements for broker-dealers
- The reporting standards for mutual fund holdings
Correct answer: Rules ensuring investors receive the best available prices across trading venues
Regulation National Market System (Reg NMS) establishes rules to ensure that investors receive the best possible price for their equity orders across all trading venues.
Question 2: What is a 'rights offering' in equity markets?
- A legal proceeding allowing minority shareholders to sue the board
- An offer to existing shareholders to purchase additional shares at a discounted price before a public offering (Correct answer)
- A government mandate requiring companies to issue shares to employees
- An option granted to executives to buy company stock at market price
Correct answer: An offer to existing shareholders to purchase additional shares at a discounted price before a public offering
A rights offering gives existing shareholders the right to purchase additional shares at a discount to the market price, allowing them to maintain their proportional ownership.
Question 3: What is 'payment for order flow' (PFOF)?
- A fee charged by exchanges to brokers for processing large orders
- A practice where brokers receive compensation from market makers in exchange for routing customer orders to them (Correct answer)
- A system where investors pay a premium for priority order execution
- A regulatory charge imposed on high-frequency traders
Correct answer: A practice where brokers receive compensation from market makers in exchange for routing customer orders to them
PFOF is a practice where brokers receive payments from market makers or trading venues in exchange for directing customer order flow to them, which can create potential conflicts of interest.
Question 4: What is the purpose of a 'lock-up period' following an IPO?
- To freeze trading in a stock when volatility exceeds a threshold
- To restrict insiders and early investors from selling shares for a set period after the IPO (Correct answer)
- To prevent retail investors from buying IPO shares on the first day of trading
- To lock in the IPO price for a set number of trading days
Correct answer: To restrict insiders and early investors from selling shares for a set period after the IPO
A lock-up period (typically 90–180 days) prevents company insiders, founders, and pre-IPO investors from selling their shares immediately after an IPO, reducing potential price pressure.
Question 5: What is 'latency arbitrage' in electronic equity markets?
- Exploiting price differences between identical stocks listed on different exchanges using slow price feeds
- Using speed advantages to trade ahead of slower market participants by reacting to market data faster (Correct answer)
- Profiting from discrepancies in closing prices across time zones
- Arbitrage between equity futures and the underlying stock using delayed settlement
Correct answer: Using speed advantages to trade ahead of slower market participants by reacting to market data faster
Latency arbitrage involves using faster technology to detect and exploit fleeting price differences before slower participants can react, a common strategy in HFT.
Question 6: What is 'share buyback' and its typical effect on earnings per share (EPS)?
- A company purchasing competitors' shares; it has no effect on EPS
- A company repurchasing its own outstanding shares; it typically increases EPS by reducing share count (Correct answer)
- A company selling treasury shares back to investors; it typically decreases EPS
- A mandatory repurchase triggered by a takeover offer; EPS is unaffected
Correct answer: A company repurchasing its own outstanding shares; it typically increases EPS by reducing share count
When a company buys back its own shares, the outstanding share count decreases, which typically increases EPS even if net income remains unchanged.
Question 7: What characterizes an 'auction market' for equities?
- Trades are negotiated bilaterally between dealers and their clients
- Buyers and sellers submit orders simultaneously, with prices determined by the matching of bids and offers (Correct answer)
- A single market maker sets prices and absorbs all buy and sell orders
- Prices are set by a central committee based on fair value estimates
Correct answer: Buyers and sellers submit orders simultaneously, with prices determined by the matching of bids and offers
In an auction market, all buyers and sellers submit orders simultaneously, and prices are determined by the intersection of supply and demand through a matching mechanism.
FIA Equity Markets & Trading 5
What does 'Regulation NMS' primarily govern in US equity markets?