Introduction to Securities Domain
1
Objective


Creation of a foundation in Securities Domain
• Exposure to terminology
• Understanding of basic products
• Understanding of trading markets and regulations
• Understanding of brokerage operations
Encourage further exploration of topic areas
Foundation for Domain Certification Course
2
Agenda

Part 1a: Introduction to Financial Instruments
• Stocks, Bonds, Derivatives, Packaged Products.

Part 1b: Introduction to Financial Marketplace
• Market Development, Order Types, Stock Markets, Margin Trading.

Part 2: Introduction to Brokerage Operations
• Execution, Settlement, Clearing
3
Why does an institution need money?

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Establish New Business
Expand Existing Business
Pay off Existing Loans
Buy other institutions
The needs for capital are numerous, like those of any individual
4
How do one raise capital?
Equity – Share Ownership
-
Shares / Stocks
High return, Liquidity, Capital
appreciation, Limited Liability
Debt – Take Loan
Bond Offerings
- Low Risk, Poor Hedge against Inflation,
Fixed Yield
Founders (friends and family)
Banks
Government
Venture Capitalists
Broker Dealers
Shares and Bonds are fundamental products. Other products are derived
5
Equity – Stock terminology



Authorized stock – Outlined in corporate charter
• Issued Stock (A)– The portion of authorized stock that is actually sold to
investors by a corporation
• Treasury Stock (B)– Stocks that have been bought back by the company that
issued them.
• Outstanding Shares – Stocks remaining with the various investors (A-B)
• Common Stock
• Preferred Stock
Par Value / Face Value- Arbitrary value placed on common stock at the time of its
authorization; Important only for accounting purpose
Market Capitalization- Market value of the company’s stock = Share Price * Number
of shares outstanding (Publicly held)
6
Preferred Stock vs. Common Stock

Preferred Stock
• Pays a fixed dividend
• Par Value
• No voting rights
• Acts more like bond than a stock
• In U.S. often bought by other
•
corporations
Has preference over common stock
when it comes to Bankruptcy and
Dividends

Common Stock
• Junior Status
• Ownership
• Ease of Transfer
• Voting rights
• Dividends and /or capital
•
•
growth
Issuer gives up control
(ownership)
Investor may receive
dividends/appreciation
Common stock - Ownership; Preferred shares – No Ownership
7
Stock IPO – Primary Markets

Sale of stock to public for the first
• Registration statement filed with Securities and Exchange Commission (SEC)
• Underwriting - The investment banker functions as an intermediary
(Underwriter) between the issuing corporation and the investors
• Underwriter offers stocks to the general public and institutions for sale through
selling group members (e.g. CSFBDirect)
• Prospectus Issue - Legal documents explaining the financial facts important
to an offering;must precede or accompany sale of primary offering
• Issue subscribed to by investors
IPO – Initial Public Offering
8
How can a company pay its shareholders?



Stock Dividend – Giving
more shares for existing
shares at a predefined
ratio eg. 2:1- Two shares
for every one share
currently held
Stock Split – Break a
share into multiple shares
Shares
Before Split
Type of
Split
Shares After
Split
100
2 for 1
200
100
4 for 1
400
100
3 for 2
150
100
1 for 2
50
Cash Dividend – Give
cash at a particular
percentage of face value
– 10% Dividend
Objective is to increase liquidity and shareholder value
9
American Depository Receipts

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Foreign country shares traded in US
Bank purchases ordinary shares of the company
Shares are deposited in a local custodian bank
ADR issued by US depositary bank (e.g. BNY)
India
ADR trade on U.S. exchanges.
Stock
ADR
US
ADRs - Selling Foreign Shares in America indirectly
10
Introduction to Bonds


Bonds are debt securities sold by a company or government to raise
money (Fixed Income Instruments)
• Bond holder becomes a Creditor but not owner of bond issuing corporation
• Bond holder receives interest yield in addition to principal amount
• Bonds characterized by finite life span (determined by Maturity period)
Issuer is responsible for repayment of principal and interest
Issuer
Investor
More Income
 Greater Safety
 Known Maturity
 Not an Owner
 Poor Inflation Hedge

Control Issues
 Risk of Default
 “Leverage” in a
Capital Structure

Bond is the other fundamental product giving fixed returns
11
Bond Terminology

Par Value- The value of a bond assigned by the issuer; also called face value.

Coupon - Paper that evidences an issuer's promise to pay interest when due

Coupon rate- The interest as a percent of par paid by a bond

Premium. The amount by which a bond sells above its par value

Maturity date- The date on which a bond is to be redeemed and its principal and
interest returned to the owner

Yield- The rate of return on an investment, described as a percentage of the
amount of the investment
12
Bond in a Nutshell
8%
$80/2
= $40
Semi-annual
interest
Semi Annual
Issuer
$1,000
Interest Payment dates
are: 1/15 and 7/15
IBM
Face Amount
1/15/25
Maturity Date
13
Bond Categories

Issuer Based Categories
• Government Securities- Issued by The U.S. government from the U.S.
Treasury and several government agencies.
• Outstanding securities on 01/19/2005 ---- $7,613,772,338,689.34
• Corporate Bonds- Bonds issues by various corporations to borrow money for
operations
• Municipal Bonds- Bonds issued by states, cities, counties and various districts
to raise money to finance their operations or to pay for infrastructure projects.

Convertible Bonds
• Bonds convertible into common stock
• Generally lower coupons as there is upside for investors
14
Derivatives
$1,200
One Month Later
$ 175
Save
Pay $25 and Book TV
Buy One Month Later
Pay Today’s Price
$1,000
Buy
Today
$ 850
One Month Later
$ 175
Lose
There is no deal without a TV here – Fundamental Product
15
Options

Terminology
• Rights and Obligations (to buy or sell)
• Specific Stock (Round lot)
• Specific Time Frame (Expiration date)
• Specific Price (strike)
• Premium

Reasons to buy Options
• Directional Speculation
• Volatility Speculation
• Protection of Stock Position
• Income Generation

Getting out of options
• Liquidate or Buy Back in Market
• Exercise
• Expiration
16
Options Trading
Option Buyer
“I have a Right”
(Control)
“I paid $”
Buyers Have rights
“are in Charge”
Pay for the privilege
Option Writer
“I have an Obligation”
(No Control)
“I got paid $ ”
Sellers take on
obligations
“Are Passive”
Get paid for their
promise
17
Call Options
Call Buyer
Right to Buy
(Control)
Call Writer
Obligation to
Sell
(No Control)
Bearish
Bullish
Call Option – Right to Buy assumes price would go up
18
Put Options
Put Buyer
Right to Sell
(Control)
Put Writer
Obligation to
Buy
(No Control)
Bullish
Bearish
Put Option – Right To Sell, Assumes Price to Go Down
19
Rights & Warrants


Rights
• Securities issued by corporation
• Shareholders maintain percentage ownership
• Rights offering and standby underwriting
Warrants
• Right to buy shares of stock at a specific price.
• Warrants are issued by a corporation
• Warrants may be long-term or perpetual.
• Attached to bond or part of unit
• Low cost capital raise
Rights and Warrants - Issued by Corporation , not between two parties
20
Mutual Funds


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
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Pool of Investors Money
Financial Expert Manages
money
Buys Multiple Company
Shares
Investors own units that are
priced proportionately
Value of units change based
on fluctuations in share
prices
Dividends and Capital
Appreciation
Diversification at low cost
Stock
Number
Market Price
Total Price
IBM
100
$ 20
$ 2,000
MSFT
200
$ 30
$ 6,000
Oracle
500
$10
$ 5,000
Total
-
-
$13,000
No. of Units
1000
Per Unit Price
$ 13
Mutual Funds – Owning shares indirectly
21
Fund Terminology

Net Asset Value - The value of a single unit of the fund determined on a daily basis

Management fee - The fee charged to compensate those who run the fund's portfolio;
Approximate around one percent of the fund's assets

Fund Types - Sales Charges i.e. fees payable while buying/redeeming shares in the fund
• Front end load Funds- Charges levied when shares in the fund are purchased
• Back end load Funds- Charges levied when shares in the fund are redeemed
• No load Funds- No sales charge

Fund Types - Continuous / Time Bound
• Open end funds- Issue new units continuously as investors buy them. Investors
redeem their units directly to the fund,
• Closed end funds- Issue a fixed number of units. Fund may redeem only upon
termination of the fund's trust. Unit holders may sell their units to other investors.
22
Annuities

Guarantees returns over a period of time, based on initial
investment

Monthly income plan, Purchasing power risk

Fixed Annuities



Money invested in general account

Pays a fixed monthly income at retirement
Variable Annuities

Pays variable monthly payment at retirement

Investment risk
Immediate or deferred Payout
23
Reading Material
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http://www.brokerage101.com/ - Section on Marketable Securities
http://www.invest-faq.com/
http://www.fool.com
http://www.investopedia.com
http://stocks.about.com/ - Equities
http://mutualfunds.about.com/ - Mutual Funds
http://www.annuityfyi.com – Annuities
- Futures and Options
http://stocks.about.com/od/bonds/ - Bonds
24
Financial Marketplace

Development of Trading Markets

Order Types

Secondary Markets
• NYSE
• NASDAQ

Margin Trading
25
Market Development




Buyers and Sellers exist like any other market
“Bidders” are Buyers
“Askers” are Sellers
Difference between the Bid and Ask is the Spread
Sell 500 shares
@ $20.25
Potential Buyer
= Bid
Buy 300 shares
@ $19.50
Price Differences prevent a deal
Potential
Seller =Ask
26
Market Development



New bidders and Askers enter
Old Bidders and Askers exit
Existing Bidders and Askers change price and quantity
Sell 500 shares
@ $20.25
Potential Buyer
= Bid
Buy 750 shares
@ $20.00
Prices match ultimately for a deal; Volume Not necessarily
Potential
Seller =Ask
27
Trading Positions

Long position - Buy Followed by Sale
• Securities owned by an investor

Short Position – Sale Followed by Buy
• Securities not owned by an investor, Relevant only when you sell

Selling Short - The sale of a security that the investor does not own in order to
take advantage of an anticipated decline in the price of the security.
• To sell short, the investor must borrow the security from his broker in order to
make delivery to the buyer
• The short seller will eventually have to buy the security back, or buy to cover,
in order to return it to the broker
In the long run, any investor is expected to close the position
28
Market Order
CUSTOMER
SIZE
BIDS (BUYERS)
Hard Line Brokerage
30,000
$ 60.00
Top Notch Advisors
15,000
$59.95
Reckless Securities Inc
25,000
$59.89
Lighting Execution Inc
20,000
$59.81
Rumor Mill Brokerage
10,000
$59.73
HI IQ Capital
30,000
$59.65
“Sell 100,000 Shares at the Market”
Order to buy or sell a stock as soon as possible at the best price available
29
Market Order
CUSTOMER
SIZE
Offers (Sellers)
Blue-Chip Brokerage
30,000
$60.00
EZ Trade Corporation
15,000
$59.85
Walck Discounters
5,000
$59.80
Klick Quick Trade
35,000
$59.60
Halasy Investors
15,000
$59.55
Murphy Retail Investors
30,000
$59.40
“Buy 100,000 Shares at the Market”
Order Format - XYZ, Sell, 100
Price , Time, Quantity – Order of Preference for any trade
30
Limit Orders




Placing a price parameter on
order
$20.50
Not guaranteed execution,
but if executed, will receive
a better price than the
current market price.
$20.25
Order to buy or sell a stock
only at the specified price
(the limit price) or better;
Safer way for trading
$19.50
Format for order
• XYZ, Sell, 100, $20.25
$20.00
$19.00
$18.75
Sell Limit
Orders
Current
Price
Buy Limit
Orders
$18.50
Buy limit price < Current market price, Sell limit price > Current market price
31
Sell Stop Order
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

$20
Buy @ Market
$18
Sell Stop Order
(stop-loss order)
Used to protect a long position
Placed below the market
Two Step Process:
• 1. “Activation price” or “Trigger price”
• 2. Once “activated”, it becomes a market order
Order Format – XYZ, Sell, 100, $18
• Market Price could be $ 20
32
Sell Stop Order
1. Buy 100 XYZ @ the market price of $20.00 (long position)
2. Places the following order to protect his long position:
Sell 100 XYZ $18.00 stop GTC
Three days later the following trades take place:
$18.25
Open
$18.15
$18.05
$18.00
$17.90
$17.85
$17.75
Activation Price / Execution Price ?
33
Buy Stop Order
$22
$20
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

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Buy Stop Order
Short Sale
Used to protect a short position
Placed above the market
Two Step Process:
• 1. “Activation price” or “Trigger price”
• 2. Once “activated”, it becomes a market order
Order Format – XYZ, Buy, 100, $22
• Market Price could be $ 20
34
Buy Stop Order
1. Sell Short 100 XYZ @ the market price of $20.00 (Short position)
2. Places the following order to protect short position:
Sell 100 XYZ $22.00 Stop GTC
Three days later the following trades take place:
$21.75
Open
$21.85
$22.00
$22.10
$22.15
$22.25
$22.30
Activation Price / Execution Price ?
Stop-Limit Order- Like a stop Order but after activation becomes a
limit Order instead of Market Order
35
More Order Types


All-or-None Order (AON)
• No partial executions
• Broker has all day to execute order (no urgency)
Immediate-or-Cancel Order (IOC)
• Partials are acceptable
• Fill immediately (urgency), and cancel unfilled balance

Fill-or-Kill Order (FOK)
• Fill immediately
• No partials
• If entire order cannot be filled immediately, then cancel order

Day Order
• Good for the day
• If not executed within the course of day, order is canceled.
GTC Order
• Also known as an “open order”.
• Order is in effect until executed or canceled by the customer

36
All Fall in Line

CUSTOMER
SIZE
Offers (Sellers)
Blue-Chip Brokerage
30,000
$60.00
EZ Trade Corporation
15,000
$59.85
Walck Discounters
5,000
$59.80
Klick Quick Trade
35,000
$59.60
Halasy Investors
15,000
$59.55
Murphy Retail Investors
30,000
$59.40
Someone records and tracks order information to ensure the best
deal for everyone
Building Block for a stock exchange
37
Quiz

I placed a sell order for CSCO, even though I never bought any shares of
CSCO. What have I done?

Bought GOOG at $230, am hoping it will go up, but I also want some
protection in case it goes down, what can I do?

If MSFT issues 85 Million shares and decides to buy back 6 Million
shares, how many shares are outstanding in the market?

How many shares of MSFT are authorized in the above case?

What is the market capitalization of MSFT if the market price is $10 per
share?

If MSFT declares a 10% dividend, what amount would I get if I own 2000
shares?
38
Regulatory Bodies

Securities and Exchange Commission (SEC) www.sec.gov
• Responsible for administering and enforcing the federal securities laws, and
regulating brokerage firms, investment companies and advisers
• Ensures orderly market performance and information availability to investors
• Establish accounting norms for securities transactions

National Association of Securities Dealers (NASD) www.nasd.com
• Works to aid and safeguard investors by regulating markets, formulating
guidelines, facilitating dispute resolution and monitoring member activities
39
Stock Market Players

Broker – A person or firm that facilitates trades between customers
• Acts only as an intermediary and does not assume risks for the trade
• Charges commissions

Dealer – A person or firm that buys and sells from his or her own inventory of
securities as well as for others
• Assumes risk for the transactions
• Marks securities up or down to make a profit on their transactions

Registered Representatives – An individual who has passed the NASD's
registration process and is therefore licensed to work in the securities industry
• Follows NASD rules.
• Usually a brokerage firm employee acting as an account executive for clients
• Sell to the public; they do not work on exchange floors
40
Market Classification
Secondary Markets - Market for outstanding issues
Exchange Markets
OTC Markets
Stock Exchange
(NYSE, AMEX etc)
 Private association of
Over the Counter (OTC)
market (NASDAQ)
 Negotiated market, without
a central trading floor
 Composed of network of
brokers and dealers
 Bid/ask quotes given by
market makers
brokers
 Auction type of trading
 Central meeting place
where members trade in
listed securities
Hybrid Market
41
42
Exchange Markets
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

Auction Markets
Specialists
Centralized
Listing standards
NYSE is the model
NYSE - SRO
43
The New York Stock Exchange
44
What does the NYSE do?

Trading and trading services
• NYSE charges (directly and indirectly) for trades that occur and for software
supplied to its members.

Listing
• To be listed on the NYSE, a corporation must meet/maintain certain financial
standards and pay listing fees.
An NYSE listing is a certification that enhances a firm’s credibility.


•
Information
• NYSE is (indirectly) an information vendor.
Regulation
• NYSE monitors and regulates the trading activity of its members.
• Through the listing relationship and the listing standards, it can affect corporate
governance behavior.

Other Information
• Traditional Auction Market with 2800 Companies Listed and 460 Non US Listings
from 48 countries
• Listings war with NASD / Overseas markets
• Ownership Structure-1366 Seats (constant since 1953)
45
Specialist Role

The Post
• Each security is assigned a particular spot on the trading floor.
• All activity for each security takes place at the security’s post
through open outcry.

The specialist as auctioneer

The specialist may act as either principal or agent
Role of the Specialist
• Maintains a fair and orderly market
• Provides liquidity
• Resolves order imbalances
Floor Brokers
• Act in an agency capacity
• No risk is assumed on transaction
• Compensation is a commission

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46
OTC Markets
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

Transactions that occur off the floor
of an exchange
Negotiated Market
Market makers
Decentralized
Nasdaq is the model for OTC markets
NASD – SRO
Not face to face
Bids and offers entered via phone or
computer
Market Makers willing to sell or buy
47
NASDAQ
48
NASDAQ ?

Electronic communication and execution network

Market Makers post prices to buy and sell

Think of shopping @ 100s of stores

Inventory of stocks

Computer automatically finds the best prices- inside market

Nasdaq is an NASD operated electronic quote system .

Two tiers of Nasdaq:
1. Nasdaq National Market (NNM)
2. Nasdaq SmallCap

2872 Company Listings
11,000 registered traders with 790 firms
1.2 million terminal users in 82 countries


49
Role of the Market Maker
A Dealer Market uses multiple
dealers, known as Market Makers.

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
Compete for investor orders
Commit capital
Maintain inventories
Seek the other side of a trade
Trade on both sides of the market
Generate investor interest
50
Margin Trading

A process whereby a brokerage client uses credit to finance securities
transactions

Allows its clients to buy securities with money borrowed from the broker

Margin requirements can be met by the investor with cash, eligible
securities, or any combination thereof

Governed by regulations of Federal Reserve, NYSE and the brokerage
firm’s internal rules

Not all securities can be traded through margin account-

Federal Reserve Board specifies “Margin securities” i.e. securities
eligible for trading through Margin account
Margin Account - Collateralized loan from a broker-dealer regulated by Reg T
51
Margin Trading Process
Margin Interest Rate
Call Loan Rate
Bank
Customer
Broker
Hypothecation
Rehypothecation
52
Quiz

I placed a market order for AAPL, but my order did not find its way into
the specialists’ book. Why?

If you own a security, would you ask for an ASK or a BID quote?

Name one auction exchange in the US?

Name one OTC exchange in the US?

If a $1000 15-year par value bond paying 6% semi-annual coupon is
selling in the Market at $1007, is the bond selling at a Premium or at a
discount?

In the above case, what is the coupon amount that the investor receives
every 6 months?

If I have a put option on BONY / BK at $29 today and the market price is
$32.20, should I exercise the option?
53
Part 2 – Brokerage Operations


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
Execution Processes
Clearing Processes
Settlement Processes
Post Settlement Processes
Benefits of Outsourced Clearing
54
Stock Trading : A Client Perspective
What’s so difficult about buying and selling stock?
55
The Reality






Trade processing is complex
Many different areas of a firm are involved in a trade
Trade processing methodologies grew up in a paper-driven environment.
Complex system of checks, double checks and triple checks to safeguard the
firm and client
Today: Intermediaries (e.g. Pershing; DTCC)
Old World
• Examination of trade processing in
•
•
•
•
a paper-based environment
Low volume
Trade by trade settlement
Firms deals directly with oneanother
Slower and volume sensitive

Modern World
• Examination of trade processing in
•
•
•
•
an electronic environment
High volume
Net settlements
Firms deal with Centralized Counter
party
Volume insensitive and high speed
Brokerage Services is a multi-billion dollar industry
56
Life of a Trade
Order
Execution
Clearing
Settlement
57
Pershing’s View
1.Order
Management
2.Trade
Processing
3.Trade
Allocation
4.Trade
Agreement
58
Order Initiation


Incoming Orders
Solicited by RR or at client’s direction
• In person
• Phone Call
• Internet
Order Initiation
Order Capture
Order Handling
Order Routing
Execution Match
and Reporting
Execution
Order Creation
Solicitation or Receipt of Customer Orders is Order Initiation
59
Order Ticket Information








Purchase or Sale
Long sale vs. Short Sale
Security
Quantity
Type of order
(market/limit/stop)
Solicited vs. unsolicited
RR Identifier
GTC or day
SELL
Obtaining correct information is critical for execution and other subsequent activities
60
Order Capture
Order Initiation

More Work Prior to placing the
Order (System checks &
Reviews)
• Internal checking of order
• Is the “ticket” filled out
correctly?
• Is all information there?
• Is client cleared to do this
type of trading?
• Does the client have
sufficient assets
($/securities) in account?
(credit limits)
• Shorting? Are securities
available?
Order Capture
Order Handling
Order Routing
Execution Match
and Reporting
Execution
Order Creation
61
Order Handling

Order Initiation
Order Rooms
• Receipt of incoming orders from
RRs
• Branch level or centralized for
entire firm
• Organize pending orders based on
security type, market, client type,
size, etc.
• Determination if trade is internal or
goes to the street
Order Capture
Order Handling
Order Routing
Execution Match
and Reporting
Execution
Order Creation
62
Dealer or Principal Capacity
Broker or Agency Capacity
Subject to risk on transaction
Mark-up or markdown
No risk on transaction
Commission
63
Order Routing
Order Initiation






Routing
• Client’s preferences?
• Broker Dealer’s preferences?
Routing to NYSE floor
Regional exchange
Relationships with specialists
Speed vs. Liquidity vs. Cost
Execution occurs at this stage
Order Capture
Order Handling
Order Routing
Execution Match
and Reporting
Execution
Order Creation
64
Life of a Trade
Order
Execution
Clearing
Settlement
65
Execution Match and Reporting



Internal
• Receipt of execution reports from trading venue
• Tie together orders and executions
• Correct security / quantity / client?
• Clean up of execution errors
• Research of un-entered/unexecuted orders
SRO
• Report of executions to SRO
• Exchanges have systems to track executions
• SROs looking for violations/patterns
Client
• Record executions (partial or full)
• Report executions to RR
• Report NDs to RR
• RR gives verbal/email report to client
Order Initiation
Order Capture
Order Handling
Order Routing
Execution Match
and Reporting
Execution
Order Creation
66
Execution Order Creation
Order Initiation

Before We Leave the Order Room
• Order – Potential Business
• Execution is contract between the BD and
•
•
contra firm
BD-to-client transaction is a separate
agreement
Clients do not transact business on NYSE or
NASDAQ!
Order Capture
Order Handling
Order Routing
Execution Match
and Reporting
Execution
Order Creation
67
Life of a Trade
Order
Execution
Clearing
Settlement
68
Clearing Operations
1.Order
Management
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2.Trade
Processing
3.Trade
Allocation
4.Trade
Agreement
Recording of executions
Computing monetary amounts
Comparison of trades with contra broker
Confirmation of trade with client
Booking
69
Trade Validation

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BDs, branches, RRs all given distinct
identifiers
Securities have CUSIP #s
Think of a CUSIP as a barcode which
contains issuer and issue identifiers
Trade itself is given transaction (ID) #
Contra-brokers have ids
If problem: Exception
Trade Validation
Trade Enrichment
Street Side
Submission
Trade Matching
(Customer and
/or street)
Trade Exception
Handling
70
Trade Enrichment
Trade Validation

Adding Information
• Commissions/mark-up or mark down
• Sec fees
• Taxes
• Regulatory Disclosures
• The end result is a “fully figured trade”
Trade Enrichment
Street Side
Submission
Trade Matching
(Customer and
/or street)
Trade Exception
Handling
71
Street Side Submission

Comparing the details
• Comparing trades with contra broker
• Old days: trade-by-trade or itemized
•
•
•
•
•
comparison
Street acknowledgement of trade
If OK trade is affirmed or “locked in”
Details may differ (uncompared)
Contra broker does not know the trade
Right security/right contra-party?
Trade Validation
Trade Enrichment
Street Side
Submission
Trade Matching
(Customer and
/or street)
Trade Exception
Handling
72
Trade Matching

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Notification-Generating a Customer
Confirm
Trade particulars (security price, size,
etc)
TD/SD
Where / when executed
Capacity in which the form acted
Cash or Margin
SRO Rule: Customer confirms must be
generated by completion of the
transaction
Trade Validation
Trade Enrichment
Street Side
Submission
Trade Matching
(customer and
street)
Trade Exception
Handling
73
Trade Exception Handling


Trade Problems
• Looking for problems (exceptions)
• Wrong stock / Bond ( maturity)/ Quantity
• Problem “real” (error) or “typo” (discrepancy)?
• Does the problem affect contra-broker?
• Can the trade be repaired?
• Cancels and re-bills
“As of” Trades and Corrections
• Fixing a customer/contra broker problem
• Trades mistakenly not entered
• Execution problems
• Error accounts
• Internal corrections and or contra broker
•
notification
Compliance Notification • Is a client being showed favoritism
• Does a particular RR/trader/branch exhibit
a pattern?
• Is there a system problem?
Trade Validation
Trade Enrichment
Street Side
Submission
Trade Matching
(Customer and
/or street)
Trade Exception
Handling
74
Clearing Operations
1.Order
Management
2.Trade
Processing
3.Trade
Allocation
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4.Trade
Agreement
Block Trades
Investment Managers (MFs etc)
Individual clients selected
A given trade may be split up and
confirmations generated to many clients
75
Clearing Operations
1.Order
Management
2.Trade
Processing
3.Trade
Allocation
4.Trade
Agreement
 Booking - Everyone
agrees the trade is now
processed and balanced
or booked into the firms
records
76
Life of a Trade
Order
Execution
Clearing
Settlement
77
If Trade Clears: Goal = Settlement

Settling Compared Trades
• On settlement date, the selling broker delivers to the buying broker and gets paid
•
•
(formerly trade-by-trade)
Firm to Firm transfer
$ vs. securities
78
Can Clients Cause a Failure to Settle?
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Firms agree on trade particulars
Client (seller) does not deliver
Client (buyer) does not pay
Settlement will still occur….
Contract is between firms!
Analyze reasons for fails
Record keeping to age items
One “fail” may affect multiple trades
Fails cost $
Issue buy-in to client or street
Obtain stock from safekeeping or stock loan
79
Post Settlement Events
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Cashiering (Cash Management)
• Receipt/disbursement of client funds
• Receipt/disbursement of contra broker funds
Checks
Fed Funds
Credits or debits internally
Third party payments
Accounting
• Keeps track of the cash - daily cash record
• Invoicing and payments
• Trial balance - monthly
• P&L statements
• Balance sheet
• Regulatory reports
80
Post Settlement Events

Stock Record
• Record of positions
• Tracking movements
• Identification/investigation of Breaks
• Auditing positions - physical vs. stock Record

Client Records (Customer Reporting)
• Statements
• Tax reporting
• P&L (cost basis etc)

SEC/SRO Records (Regulatory Reporting)
• Net capital
• Operational Issues
• Client extensions
• $ Laundering
• Complaints
81
Corporate Actions

Communications
• Receive information from Issuer / DTC etc.
• Review Information (Prospectus / Letter)
• Mailing Announcements
• Communications with depositories or agent banks

Outcomes
• Receipt of customer instructions
• Research and reconciliation of exceptions
• Stock record must be consulted
• Crediting/debiting accounts for $/stock

Examples
• Mergers, Spin-offs, Splits / Reverse splits
• Cash and stock, Interest allocations, Rights offerings
• Calls, Proxies, Dividends, Voting
82
Why Not Self-Clear?

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
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Cost Issues - Inefficient; Cheaper to Outsource
Financial Benefits - Cheaper cost of funds (margin), Stock loan opportunities,
Reduced net capital Needs, Reduction of contra party risk, Bulk buying opportunities
Reduced Paperwork – Confirms, Statements, Mailings, Proxies, Tax Reports
Regulations Concerns / Compliance - Patriot Act /Money Laundering, Trade
Monitoring, Net Capital Issues, 144 Sales/Accounts of Deceased/Accts -Associated
Persons Activities, DNC Lists, Archiving Records
Technology Advantages - Access to trading software, Data feeds (News and Quotes),
Access to ECNs, Trading Technology/Relationships, Access to risk management
software (Trading), Client profiling software (Compliance)
Client Peace of Mind
Why Hire Pershing? (Why Third Party Clearing Services?)
• Saves time and $
• Think of clearing on a unit cost basis
• Permits small firms to focus on what they do best (Sales and/or Trading)
83

Q&A
84