Wiley Finra Series 3 Exam Review (2019)

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WILEY SECURITIES LICENSING SERIES
This series includes the following titles:
Wiley Securities Industry Essentials Exam Review 2019
Wiley Series 3 Securities Licensing Exam Review 2019 + Test Bank:
The National Commodities Futures Examination
Wiley Series 4 Securities Licensing Exam Review 2019 + Test Bank:
The Registered Options Principal Examination
Wiley Series 6 Securities Licensing Exam Review 2019 + Test Bank:
The Investment Company and Variable Contracts Products Representative
Examination
Wiley Series 7 Securities Licensing Exam Review 2019 + Test Bank:
The General Securities Representative Examination
Wiley Series 9 Securities Licensing Exam Review 2019 + Test Bank:
The General Securities Sales Supervisor Examination—Option Module
Wiley Series 10 Securities Licensing Exam Review 2019 + Test Bank:
The General Securities Sales Supervisor Examination—General Module
Wiley Series 24 Securities Licensing Exam Review 2019 + Test Bank:
The General Securities Principal Examination
Wiley Series 26 Securities Licensing Exam Review 2019 + Test Bank: The
Investment Company and Variable Contracts Products Principal Examination
Wiley Series 57 Securities Licensing Exam Review 2019 + Test Bank:
The Securities Trader Examination
Wiley Series 63 Securities Licensing Exam Review 2019 + Test Bank:
The Uniform Securities Agent State Law Examination
Wiley Series 65 Securities Licensing Exam Review 2019 + Test Bank:
The Uniform Investment Adviser Law Examination
Wiley Series 66 Securities Licensing Exam Review 2019 + Test Bank:
The Uniform Combined State Law Examination
Wiley Series 99 Securities Licensing Exam Review 2019 + Test Bank:
The Operations Professional Examination
For more on this series, visit the website at www.securitiesCE.com.
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Cover Design: Wiley
Cover Image: © Jumpeestudio/iStock.com
Copyright © 2019 by The Securities Institute of America, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Previous editions published by The Securities Institute of America, Inc.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic,
mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United
States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the
appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax
(978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the
Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or
online at www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they
make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically
disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by
sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation.
You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or
any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department
within the United States at (800) 762-2974, outside the United States at (317) 572-3993, or fax (317) 572-4002.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print
versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that
is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more
information about Wiley products, visit www.wiley.com.
ISBN 978-1-119-55255-0 (Paperback)
ISBN 978-1-119-55257-4 (ePDF)
ISBN 978-1-119-55260-4 (ePub)
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CONTENTS
About the Series 3 Exam
Taking the Series 3 Exam
How to Prepare for the Series 3 Exam
What Type of Positions May a Series 3 Registered Principal Hold?
What Score Is Required to Pass the Exam?
Are There Any Prerequisites for the Series 3?
How Do I Schedule an Exam?
What Must I Take to the Exam Center?
How Soon Will I Receive the Results of the Exam?
About This Book
About the Test Bank
About The Securities Institute of America
Chapter 1: Futures and Forwards
The Spot Market
Forward Contracts
Futures
Trading Futures on the Floor of the Exchange
Clearinghouse
Clearing Member Margin Calculations
Basis Grade
Pretest
Chapter 2: Trading Commodity Futures
Types of Orders
Market Orders
Buy Limit Orders
Sell Limit Orders
Stop Orders/Stop Loss Orders
Buy Stop Orders
Sell Stop Orders
Stop Limit Orders
Other Types of Orders
Pretest
Chapter 3: Futures Pricing
Contract Sizes and Pricing
U.S. Treasury Futures
Stock Index Futures
Index Future Settlement
Single Stock Futures
Foreign Currency Futures
Pretest
Chapter 4: Price Forecasting
Futures Market Pricing Structure
Agricultural Futures Pricing
Supply and Demand Elasticity
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Government Agricultural Programs
Crop Year
Economic Policy
Tools of The Federal Reserve Board
Interest Rates
Reserve Requirement
Changing the Discount Rate
Federal Open Market Committee
Money Supply
Disintermediation
Moral Suasion
Fiscal Policy
International Monetary Considerations
London Interbank Offered Rate / Libor
Yield Curve Analysis
Technical Analysis
Pretest
Chapter 5: Speculation and Hedging
Speculation
Margin
Maintenance Margin
Changes to the Margin Requirement
Other Forms of Margin Deposits
Hedging
How to Manage an Imperfect Hedge
A Change in Basis Price
Hedging Financial Risks
Pretest
Chapter 6: Commodity Futures Options and Commodity Futures Spreads
Option Classification
Option Classes
Option Series
Bullish vs. Bearish
Possible Outcomes for an Option
Managing an Option Position
Buying Calls
Selling Calls
Buying Puts
Selling Puts
Option Premiums
Intrinsic Value and Time Value
Multiple Option Positions and Strategies
Long Straddles
Short Straddles
Spreads
Analyzing Spreads/Price Spreads
Bull Call Spreads/Debit Call Spreads
Spread Premiums Bull Call Spread
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Bear Call Spreads/Credit Call Spreads
Spread Premiums Bear Call Spread
Bear Put Spreads/Debit Put Spreads
Spread Premiums Bear Put Spread
Bull Put Spreads/Credit Put Spreads
Spread Premiums Bull Put Spread
Synthetic Risk and Reward
Delta
Spreading Futures Contracts
Spreading Treasury Futures
Pretest
Chapter 7: CFTC & NFA and Regulations
The Commodity Exchange Act of 1936
Futures Commission Merchant
Introducing Broker
Commodity Pool Operator
Commodity Trading Adviser
Risk Disclosure Documents
Additional Disclosures by CTAs and CPOs
Customer Accounts
Arbitration
The CFTC Reparation Process
Written Communication with the Public
Pretest
Answer Keys
Chapter 1: Futures and Forwards
Chapter 2: Trading Commodity Futures
Chapter 3: Futures Pricing
Chapter 4: Price Forecasting
Chapter 5: Speculation and Hedging
Chapter 6: Commodity Futures Options and Commodity Futures Spreads
Chapter 7: CFTC & NFA and Regulations
Glossary of Exam Terms
Index
Advert
Access Code
End User License Agreement
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About the Series 3 Exam
Congratulations! You are on your way to becoming licensed to transact business in commodity
futures and options on futures. The Series 3 exam is a 120-question exam presented in both
multiple-choice and true/false format. Each candidate will have 2 hours and 30 minutes to complete
the exam. A score of 70% or higher is required on each of the two sections to pass. The Series 3 is as
much a knowledge test as it is a reading test. The writers and instructors at The Securities Institute
have developed the Series 3 textbook and exam prep software to ensure that you have the knowledge
required to pass the test and that you are confident in your ability to apply that knowledge during
the exam.
IMPORTANT EXAM NOTE!
The Series 3 exam is one of the only exams that contains both multiple choice style questions
and true / false style questions. The Series 3 also requires a passing score of 70% in each of the
two sections of the test to pass the exam.
To contact The Securities Institute of America, visit us on the Web at www.SecuritiesCE.com or
call 877-218-1776.
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Taking the Series 3 Exam
The Series 3 exam is presented in multiple-choice format on a touch-screen computer known as the
PROCTOR system. No computer skills are required, and candidates will find that the test screen
works in the same way as an ordinary ATM machine. Each test is made up of 120 questions that are
randomly chosen from a test bank of several thousand questions. The test has a time limit of 2 hours
and 30 minutes, which is enough time for all candidates to complete the exam. Each Series 3 exam
includes questions that focus on the following areas:
Part 1
Futures Trading Theory and Futures Terminology—16 questions
Futures Margins, Options Premiums, Price Limits, Settlements, Delivery, Exercise and
Assignment—15 questions
Types of Orders, Customer Accounts, Price Analysis—11 questions
Basic Hedging and Hedging calculations—9 questions
Financial Hedging—10 questions
Spreading—3 questions
Speculation in Commodity Futures, Financial Futures—16 questions
Option Speculation, Hedging, and Spreading—5 questions
Part 2
CFTC/NFA Rules and Regulations—35 Questions
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How to Prepare for the Series 3 Exam
For most candidates, the combination of reading the textbook and taking as many practice questions
as they can proves to be enough to successfully complete the exam. It is recommended that you
spend at least 60 to 70 hours preparing for the exam by reading the textbook, underlining key
points, and completing as many practice questions as possible. We recommend that students
schedule the exam no more than 1 week after completing their Series 3 exam prep.
Test-Taking Tips
Read the full question before answering.
Identify what the question is asking.
Identify key words and phrases.
Watch out for hedge clauses, such as except and not.
Eliminate wrong answers.
Identify synonymous terms.
Be wary of changing answers.
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What Type of Positions May a Series 3 Registered Principal Hold?
Individuals who have passed the Series 3 exam may register as an associated person with an NFA
member and may transact business in futures contracts. Individuals who have passed the Series 3
exam may apply for NFA membership as associated persons of any of the following:
Sole proprietor
Futures commission merchant (FCM)
Retail foreign exchange dealer (RFED)
Introducing broker (IB)
Commodity pool operator (CPO)
Commodity trading advisor (CTA)
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About This Book
The writers and instructors at The Securities Institute have developed the Series 3 textbook and
exam prep software to ensure that you have the knowledge required to pass the test, and to make
sure that you are confident in the application of the knowledge during the exam. The writers and
instructors at The Securities Institute are subject matter experts as well as Series 3 test experts. We
understand how the test is written and our proven test-taking techniques can dramatically improve
your results.
Each chapter includes notes, tips, examples, and case studies with key information; hints for taking
the exam; and additional insight into the topics. Each chapter ends with a practice test to ensure you
have mastered the concepts before moving onto the next topic.
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About the Test Bank
This book is accompanied by a test bank of more than 150 questions to further reinforce the
concepts and information presented here. The access card in the back of this book includes the URL
and PIN code you can use to access the test bank. This test bank provides a small sample of the
questions and features that are contained in the full version of the Series 3 exam prep software.
If you have not purchased the full version of the exam prep software with this book, we highly
recommend it to ensure that you have mastered the knowledge required for your Series 3 exam. To
purchase the exam prep software for this exam, visit The Securities Institute of America online at
www.SecuritiesCE.com or call 877-218-1776.
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About The Securities Institute of America
The Securities Institute of America, Inc. helps thousands of securities and insurance professionals
build successful careers in the financial services industry every year.
Our securities training options include:
Classroom training
Private tutoring
Interactive online video training classes
State-of-the-art exam preparation software
Printed textbooks
Real-time tracking and reporting for managers and training directors
As a result, you can choose a securities training solution that matches your skill level, learning style,
and schedule. Regardless of the format you choose, you can be sure that our securities training
courses are relevant, tested, and designed to help you succeed. It is the experience of our instructors
and the quality of our materials that make our courses requested by name at some of the largest
financial services firms in the world.
To contact The Securities Institute of America, visit us on the Web at www.SecuritiesCE.com or call
877-218-1776.
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The Spot Market
Before the development of financial instruments and contracts, commodities were bought and sold
in cash transactions. The transactions between the producer or seller of the commodity and the user
or buyer of the commodity took place in the cash or spot market. In the spot market the producer of
the commodity would bring his crop to the marketplace and sell the wheat or corn to any buyer with
cash in hand. The spot market gets its name from the fact that the commodity is delivered and paid
for “on the spot.” The producer of the commodity who has the commodity on hand is said to be long
the cash commodity. If the grower of corn has 100,000 bushels of corn stored in their silo, the
farmer (producer) is said to be long 100,000 bushels of cash corn. The user of the commodity who
does not have the commodity on hand but who needs to acquire the cash commodity in order to
produce their product or to conduct their business is said to be short the cash commodity. A grower
of cattle who needs the corn to feed his cattle would be considered to be short cash corn because the
grower does not have the corn on hand and needs the corn to conduct his business and to feed his
cattle. Alternatively, someone who has a contractual obligation to deliver the underlying cash
commodity but who does not own the cash commodity would also be considered to be short the cash
commodity. If a U.S. exporter has contracted to deliver 50,000 bushels of corn to a cattle grower in
Mexico in 120 days but has not acquired the 50,000 bushels of corn, the exporter would be
considered to be short cash.
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Forward Contracts
The first advancement in commodity trading was the development of cash forward contracts or
forwards. Forward contracts are privately negotiated contracts for the purchase and sale of a
commodity or financial instrument. The first forward contracts were developed for agricultural
commodities like wheat and corn. The establishment of forward contracts allowed the buyer and
seller of commodities to lock in prices for a delivery date in the future. The forward contract gave
both parties the ability to manage their businesses more efficiently. Farmers could now grow crops
knowing that they had locked in a sale price for the crop. The forward contract also allowed the
farmer to sell their crop without having to haul it to market, hoping there were buyers waiting with
cash in hand. The buyer or users of the commodities through the use of a forward contract now
knew that they had locked in the supply of the commodity to meet their demand at a set price. Both
parties to the forward contract have an obligation to perform under the contract. The buyer is
obligated to accept delivery of and pay for the commodity at the agreed-upon time and location. The
seller is obligated to deliver the stated amount and quality of the commodity at the agreed-upon
time and location. Because the terms and conditions for each forward contract are negotiated on an
individual basis, it is extremely difficult to find another party to take over the obligation under the
contract should circumstances change between the contract date and the delivery date. There is no
secondary market for forward contracts. Another drawback to the forward contract is counterparty
or performance risk. The individual counterparty risk is borne by both parties to the forward
contract. For the seller or producer of the commodity it is the risk that the buyer will not be able to
make payment or take delivery. For the buyer of the commodity the counterparty risk is that the
farmer may not be able to produce or deliver the commodity. If one party defaults on their
obligation to perform under a forward contract there is no entity to step in to ensure that the other
party is made whole. In modern financial markets, forwards are often used in the currency markets
by corporations and banks doing business internationally. If a corporation knows that it needs to
make a payment for a purchase in foreign currency 3 months from now, the corporation can arrange
to purchase the currency from a bank the day before the payment is due.
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Futures
As the use of forward contracts evolved, the need to offset obligations through a secondary market
and to eliminate counterparty risk led to the development of commodity futures contracts. Futures,
like forwards, are a two-party contract. The specific terms and conditions of the contracts are
standardized and set by the exchanges on which the futures contracts trade. The contract amount,
delivery date, and type of settlement vary between the different types of futures contracts. Many
futures contracts are an agreement for the delivery of a specific amount of a commodity at a specific
place and time such as 5,000 bushels of wheat during the delivery period of the contract month.
Futures began to trade for commodities such as wheat and gold and over the years have expanded to
include financial futures such as futures on Treasury securities and most recently single stock
futures. The standardized contract terms allows for a very liquid secondary market. The
counterparty risk has been eliminated through performance guarantees. So even if one party to a
contract defaults and does not meet their obligation, the other party will be made whole. Investors
and hedgers can establish both long and short positions in commodity futures contracts. A person
who has purchased the futures contract is long the contract, and until the buyer executes an
offsetting sale the contract remains open. Alternatively a person who has sold the futures contract to
open the position is considered to be short the futures contract, and until the seller closes out the
contract with an offsetting purchase the contract remains open.
The Role of the Futures Exchange
The futures exchange at the most basic level provides a centralized location where buyers and sellers
come together to transact business in futures. The exchange provides a centralized location where
producers and users of commodities can lock in prices, manage their business, and hedge their risks.
A farmer can lock in a sales price for his corn production by selling corn futures. A baking company
may lock in a price for wheat by purchasing wheat futures. By engaging in futures transactions, the
producer of corn and the buyer of wheat have both hedged their risk and can now operate their
businesses more efficiently and without immediate concern over large price swings. The use of
futures contracts has resulted in a reduction in business risk and commodity costs. These cost
savings are passed along to the economy as buyers of the finished product enjoy the lower prices for
finished goods like a loaf of bread. Additionally, because futures reduce the business risk to the
producers and users of commodities, these companies are now able to obtain credit at lower rates. A
lender reviewing the loan application of a farmer who grows corn will be more confident in making
the loan if the lender knows that the farmer has locked in a sale price for his product. Finally, the
exchange provides a place for risk capital to speculate on the direction of various commodities.
These speculators provide a significant level of liquidity to the marketplace and make it easier for
producers and users to hedge their business risk in the underlying cash commodity. These
speculators are willing to assume the risk that producers and users want to eliminate.
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Trading Futures on the Floor of the Exchange
Only individuals who own a membership on the exchange may conduct business on the floor of the
exchange. A firm must be associated with an individual who owns a membership to qualify as a
member firm. Futures exchanges, like other exchanges, are self-regulatory organizations and are
responsible for establishing rules for their members and ensuring members adhere to just and
equitable trade practices. The futures exchanges have the authority to investigate members and
assess fines and penalties if the exchange finds that a member has violated its rules. The exchange
establishes the margin requirements that must be deposited to establish a position for each futures
contract. This is known as original margin. The exchange also establishes the minimum amount of
equity or margin that must be maintained to continue to hold the position. This is known as
minimum maintenance margin. Futures trading on the floor of the exchange takes place in the
futures pit for the specific contract. For a long time trades for futures contracts were not allowed to
take place away from the pit or outside the ring. While many securities listed on a stock exchange
also trade in the over-the–counter (OTC) market, futures contracts were not traded OTC or off the
floor. All trades were executed on the floor of the exchange in the pits. As the trades occur, the floor
reporter would report the trades to the tape for dissemination to the marketplace. The report to the
tape would be sent throughout the world to interested parties who transact business in futures
contracts, much the same as a trade in the stock of an NYSE-listed company is disseminated. Orders
for each type of futures contract would be directed to the pit for execution. Floor brokers and floor
traders would come together in an open outcry market to announce their respective bids and offers
for the contracts. A floor broker is an employee of a member organization and will execute orders for
the member's customers and for the member's own account. A floor trader is a member of the
exchange who trades for his or her own account. Floor traders are also known as locals or scalpers.
These members stand in the pit to trade futures contracts for their own profit and loss. Some locals
will simply day trade to make the spread on the contract or try to earn a quick profit on a small move
in the price of the contract. The practice of day trading on small moves is the origin of the term
scalper. Other floor traders will take positions overnight or for longer periods of time. These floor
traders are known as position traders. Floor traders are not obligated to take on positions nor are
they required to buy or sell in the absence of orders or if the spread in the contract price becomes
excessive. The exchange's floor committee sets the rules for trading futures on the floor of the
exchange and will resolve trading disputes between members. The CME Group which owns the
Chicago Mercantile Exchange, the NYMEX, CBOT, and the KCBOT now allows approved firms to
display bids and offers for contracts “on the screen” through CME globex electronic trading
platform. Orders executed by firms with technology trading privileges will clear through the
exchange as a futures contract.
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Clearinghouse
All commodity exchanges must have a clearinghouse to clear all commodities futures transactions
executed on the floor or clear through the exchange. The clearinghouse guarantees contract
performance and eliminates all counterparty risk. If one party to a contract defaults the
clearinghouse will ensure the financial performance of the contract, but not the actual delivery of the
underlying commodity. All transactions in futures contracts are two-party contracts and each party
accepts an obligation at the time the trade is executed. Neither the buyer nor seller of the contract
knows the identity of the other party to whom they are now obligated. The clearinghouse is the
ultimate counterparty for each buyer and each seller of futures contracts. If the buyer of a futures
contract did not wish to take delivery of the underlying commodity, the buyer could simply offset his
futures position with an offsetting sale of the contract. All offsetting transactions must be executed
on the floor or clear through the same exchange and in the same futures contract month to close out
the position.
EXAMPLE
A gold miner in Colorado who is concerned about the value of gold falling before the gold can
be extracted sells a gold futures contract to a speculator in New York who believes that the
price of gold is likely to increase in the next few weeks. Both the miner and speculator have now
taken on an obligation to each other. The miner is obligated to deliver the gold and the
speculator is obligated to purchase the gold. If the speculator determines that the price of gold
is not likely to increase any further and does not want to accept delivery of the gold, the
speculator would simply sell the gold contract. This offsetting transaction in no way affects the
miner in Colorado who is still obligated to deliver the gold. The clearinghouse will assign the
delivery to another market participant who is long the gold futures contract at the time the
miner sends notice of intent to deliver the gold.
When a buyer or seller of a futures contract offsets his or her position they have effectively exited the
market and are no longer obligated to any party.
Firms that transact business in commodity futures who are members of the clearinghouse will
report all of their transactions to the clearinghouse. The clearinghouse will net the purchases and
sales for all transactions executed during the trading session. Based on the trades that are reported
to the clearinghouse by clearing member firms, the clearinghouse will calculate the original margin
requirement that must be deposited by each member firm. Trades in futures contracts settle the next
business day and the member firm must deposit the required margin by the open of the next trading
day.
EXAMPLE
ABC commodities is a clearing firm member. During the course of the trading day ABC had
customers establish new long positions in gold futures of 100 contracts. During the same
trading day ABC also had customers who established new short positions in gold futures of 60
contracts. ABC would report to the clearinghouse that it had established 100 long contracts in
gold futures and had established 60 short contracts in gold futures.
The clearinghouse would then calculate the original margin that must be deposited by ABC
commodities for these positions. Most clearinghouses will net the positions to determine the
amount of original margin that must be deposited. In this case ABC customers went long 100
contracts while other ABC customers when short 60 contracts. If the clearinghouse nets the
positions, ABC will only be required to deposit the original margin for 40 long gold contracts.
TAKENOTE!
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ABC would still be required to collect the original margin from its customers in the above
example for all 100 long contracts and all 60 short contracts.
All commodities futures merchants must clear all transactions through the clearinghouse. The
merchant may do this by becoming a member of a clearinghouse or the merchant may find it easier
to have another clearinghouse member provide the clearing functions for its transactions and will
pay the clearinghouse member a fee for this service.
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Clearing Member Margin Calculations
Original margin refers to the amount that a member firm must deposit to establish a position in a
futures contract. The amount of the original margin requirement is set by the exchange. Once the
position has been established the clearinghouse will measure the amount of margin (equity) on
deposit in relationship to the market price of the futures contract to determine if the position
remains above the minimum maintenance for the contract. This process is known as marking to the
market. As the price of the futures contract changes, the amount of margin on deposit will change in
relation to the change in price of the futures contract. If the price of the futures contract moves
against the member firm the amount of their margin deposit will be reduced. Should the contract
move sufficiently against the firm, causing the deposit to fall below the minimum maintenance level,
the clearinghouse will issue a call for additional or variation margin. A call for additional margin
must be met by the next business day. When the clearinghouse marks to the market, the price for
the contract is based on the official settlement price established and published by the exchange at
the close of each trading day. In the rare event that no trades have taken place in a particular
contract, the exchange will select the midpoint of the spread between the bid and the ask to
determine a settlement price. During times of extreme volatility a clearinghouse could issue a call
during the trading day for additional margin. In these extreme events a margin call issued during
the trading day must be met within 1 hour.
Alternatively if a futures position moves in favor of the clearinghouse member, causing an increase
in the margin (equity) on deposit for the contract to be in excess of the original margin requirement,
the clearinghouse will send the excess back to the clearinghouse member.
Unlike a margin account for equities there is no loan being made to the customer and there is no
debit balance or interest charged.
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