Capital Markets Basics for the SIE Exam (Section 1)
Section 1 of the SIE is 16% of the exam, or 12 scored questions. Covers regulators, market structure, offerings, participants, and economic factors.
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Knowledge of Capital Markets is Section 1 of the FINRA SIE content outline. It carries 16% of the exam, which works out to 12 of the 75 scored questions.
The section answers five questions:
- Who regulates the securities industry?
- Who are the players?
- How are the markets structured?
- How do new securities reach investors?
- How does the economy move prices?
Study it first. It supplies the vocabulary the other sections assume you already have.
What Section 1 asks you to do
Almost every item gives you a job or a transaction, then asks which body or which market owns it.
| Topic area | A typical question |
|---|---|
| Regulators and SROs | Which body writes the rules for municipal securities dealers? |
| Market participants | Who keeps the record of who owns the shares? |
| Market structure | Which market did this transaction happen in? |
| Offerings | Who keeps the shares that nobody bought? |
| Economic factors | Which indicator moves after the economy turns? |
Section 2 is 33 questions and Section 3 is 23, so weight your time accordingly. Our SIE exam difficulty article shows where the hard points sit.
The regulators: the SEC on top, SROs underneath
The Securities and Exchange Commission (SEC) is the federal agency that enforces securities laws. A self-regulatory organization (SRO) is an industry body that writes and enforces rules for its own members, under SEC oversight. The SEC approves SRO rules before they take effect.
| Body | Its job | Government agency? |
|---|---|---|
| SEC | Enforces federal securities laws and oversees the whole market | Yes |
| FINRA | Regulates broker-dealers and their registered people, and runs the SIE | No |
| MSRB | Writes municipal securities rules, and enforces none of them | No |
| CBOE | Regulates trading on its own options market | No |
Registration means the issuer filed the disclosures the law requires. It is never an endorsement, so "the SEC approved this investment" is always a wrong answer.
Four more bodies each own one job the exam tests:
- The Federal Reserve writes Regulation T, which sets the initial margin requirement at 50%.
- SIPC restores missing cash and securities when a member broker-dealer fails, up to $500,000 per customer, with no more than $250,000 of that in cash.
- The FDIC insures bank deposits up to $250,000 per depositor, per insured bank, per ownership category, and covers no investments.
- State securities administrators enforce blue-sky laws, the securities laws of a single state. NASAA is their membership body, and it enforces nothing.
Read a SIPC or FDIC question for the institution that failed. Neither one pays for a bad investment. Our regulatory framework guide covers Section 4.
Primary and secondary markets
Two questions sort every "which market" item. Did the issuer receive the money? Was a broker-dealer in the middle?
| Market | What happens | Who gets the money |
|---|---|---|
| Primary | An issuer sells new securities | The issuer |
| Secondary | Investors trade securities that already exist | The selling investor |
| Third | A listed security trades OTC, away from its exchange | The selling investor |
| Fourth | Two institutions trade directly through an ECN | The selling institution |
A company that has been public for years still uses the primary market when it sells newly created shares. Ignore the deal's name and ask who received the proceeds.
The secondary market runs in three venues. An exchange such as the New York Stock Exchange is an auction market, where the highest bid meets the lowest offer. Nasdaq is a dealer market, where market makers quote from their own inventory. The OTC market is a dealer network where each price is negotiated.
Third and fourth get swapped most often. A broker-dealer executes third market trades, and the fourth market has none.
How new securities come to market
The issuer sells the new securities and keeps the money. The investment banker advises the issuer and distributes the deal, and you call it the underwriter once it takes on the securities. A syndicate splits the shares, the risk, and the fee. A selling group helps sell, buys nothing, and carries no risk.
Three offering names come up constantly, and the exam swaps the last two.
| Offering | The shares | Who gets the money |
|---|---|---|
| Initial public offering (IPO) | New | The issuer |
| Follow-on offering | New | The issuer |
| Secondary offering | Already exist | The selling shareholders |
A secondary offering differs from the secondary market. It is one sale by large holders such as founders.
Two distribution methods cover most questions. In a firm commitment the underwriter buys the whole issue and keeps any shares it cannot sell. In a best efforts deal it acts as an agent, returns unsold shares, and risks nothing. A question about leftover shares is a firm commitment question.
The disclosure document follows the product.
- A prospectus goes with a registered corporate or fund offering.
- An official statement goes with a new municipal issue.
- A program disclosure document goes with a 529 college savings plan.
The cooling-off period runs a minimum of 20 days after the SEC filing. During it the underwriter may use a preliminary prospectus (the red herring) and take indications of interest, which bind nobody.
Some offerings skip SEC registration:
- Government securities
- Intrastate offerings under Rule 147
- Small offerings
- Private placements under Regulation D
Private placement buyers receive restricted securities, and Rule 144 controls the resale.
The market participants
Each player owns one defining job.
- A broker-dealer trades as an agent for a commission and as a dealer for a markup.
- An introducing broker-dealer takes the orders. A clearing broker-dealer holds the customer cash and securities, settles the trades, and sends the confirmations.
- An investment adviser charges a fee and owes a fiduciary duty. A broker-dealer earns a commission and follows Regulation Best Interest.
- A municipal advisor owes its municipal client a fiduciary duty. The underwriter on the same bond deal owes none.
- A transfer agent works for the issuer, keeps the ownership records, pays dividends, and mails proxies.
- A market maker quotes a bid and an ask and earns the spread.
Behind the trade sits the plumbing. DTC holds securities in book-entry form. NSCC nets trades and guarantees settlement at T+1, one business day after the trade. The Options Clearing Corporation (OCC) issues and guarantees every listed option.
Economic factors
Monetary policy belongs to the Federal Reserve. Fiscal policy, meaning taxes and government spending, belongs to Congress and the President.
The Federal Open Market Committee (FOMC) runs open market operations, the Fed's purchases and sales of government securities. Learn this chain in both directions. The Fed buys, the money supply grows, rates fall, bond prices rise, and stocks rally. Buy means boost, sell means slow.
Banks charge each other the federal funds rate for overnight loans. A Federal Reserve Bank charges a borrowing bank the discount rate. Bank to bank, or Fed to bank, decides the answer.
| Timing | Indicators |
|---|---|
| Leading | Building permits, new orders for durable goods, initial jobless claims, stock prices, money supply |
| Coincident | GDP, industrial production, personal income, nonfarm payrolls |
| Lagging | CPI, corporate profits, business inventories, duration of unemployment |
The business cycle runs expansion, peak, contraction, trough, then expansion again. Defensive stocks such as food and utilities hold up in a contraction, and cyclical stocks such as autos and airlines fall with it. GDP counts output inside a country's borders, and GNP counts output by its citizens anywhere. A weak dollar helps US exporters.
The CPI is the classic trap. It is a monthly headline number, so students call it leading. It lags.
What the exam emphasizes in Section 1
Section 1 rewards sorting, so one clean distinction earns the point. Five things carry most of the 12 questions:
- Which body owns the job. SEC against FINRA against the MSRB, and SIPC against the FDIC.
- Which market the transaction happened in, decided by who received the money.
- Who carries the risk in an underwriting, and who gets the money in each offering.
- Which disclosure document goes with which product.
- Which way bond prices and stocks move when the Fed acts, and how an indicator is classified.
Depth beyond that rarely pays. You will not price an option or compute a yield here, and the vocabulary carries into products and risks and trading and accounts rules.
The free SIE course covers this section lesson by lesson. Work a timed set from the practice tests directory, or take the free practice test for a section breakdown. For the official content outline, go to FINRA.