Orders, Settlement and Corporate Actions

Order types

A market order executes immediately at the best available price. It guarantees execution and nothing about price.

A limit order sets a price limit — buy at this price or lower, sell at this price or higher. It guarantees price and nothing about execution; it can be missed entirely.

A stop order is dormant until the market trades at or through the stop price, which elects it; it then becomes a market order. A stop does not guarantee the stop price — in a gapping market the execution can be far away, which is exactly what surprises customers who think a stop protects them from a crash.

A stop-limit order is elected the same way and becomes a limit order, which fixes the price problem and introduces an execution problem.

The geometry, and it is the reusable part: buy limits and sell stops sit below the current market; sell limits and buy stops sit above it. A buy limit is below because the customer wants to buy cheaper; a sell stop is below because the customer owns the stock and wants out if it falls.

Time qualifiers: a day order expires at the close; a good-til-cancelled order rests until executed or cancelled.

Execution qualifiers: all or none must be filled completely but may be worked over time; fill or kill must be filled completely and immediately or is cancelled; immediate or cancel takes whatever can be filled immediately and cancels the rest.

Orders may be solicited — the firm recommended the trade — or unsolicited, where the customer initiated it. The ticket records which, and it matters because the standard of care attaches to recommendations.

Investment returns

Three ways a security returns money, and the exam distinguishes them because their tax treatment differs.

Capital appreciation is an increase in the security's value, realized as a capital gain when sold. Held more than a year, it is long-term and taxed at preferential rates; a year or less, short-term and taxed as ordinary income.

Income is what the security pays out: dividends on equity, interest on debt. Qualified dividends are taxed at long-term capital gains rates if holding-period conditions are met; other dividends and most interest are ordinary income. Municipal interest is generally federally exempt.

Return of capital is a distribution of the investor's own principal rather than of earnings. It is not immediately taxable; it reduces the cost basis, and once basis reaches zero further distributions are taxed as gain. Recognising it matters because a distribution rate funded by return of capital is not a yield, and a customer told otherwise has been misled.

Total return combines all of these — appreciation plus income — and is the right measure for comparing investments.

Settlement

SEC Rule 15c6-1 requires that a securities transaction settle no later than the first business day after the trade date. That is T+1, and it applies to equities, corporate bonds and municipal bonds. Government securities settle next day by convention.

Other settlement terms may be agreed at the time of the trade: cash settlement is same day; seller's option gives the seller a later specified date.

Regulation T sets when the customer must pay. The payment period is the settlement cycle plus two business days, so under T+1 payment is due three business days after the trade date. Failure to pay results in liquidation and a 90-day freeze on the account, during which the customer must pay in advance.

The ex-dividend consequence follows from the cycle. A purchase on the record date settles the next business day and misses the record, so the ex-dividend date is the same business day as the record date. To receive the dividend, buy at least one business day before the record date. The stock's price drops by the dividend on the ex-date, and open orders below the market — buy limits and sell stops — are reduced accordingly unless the customer marked them do not reduce.

Settlement is centralized. The Depository Trust and Clearing Corporation holds securities in book-entry form and nets obligations between firms, so thousands of transactions become one net payment.

Corporate actions

A corporate action changes the position, the basis, or both, and the firm must notify affected customers.

A forward split multiplies the share count and divides the price: 100 shares at $60 becomes 200 at $30 in a two-for-one. Total value and total basis are unchanged; basis per share halves. Not a taxable event, and the holding period tacks.

A reverse split reduces the count and raises the price, usually to regain compliance with an exchange's minimum price standard. It creates no value.

A stock dividend distributes additional shares instead of cash, with the same non-taxable basis reallocation.

A spinoff distributes shares of a subsidiary to the parent's shareholders, with the original basis allocated between them by relative value.

A tender offer invites holders to sell at a stated price, usually above market. A holder may tender only their net long position, and trading on material non-public information about a tender offer is prohibited under a rule broader than the general insider trading law.

A merger or acquisition exchanges shares of one company for cash, shares of another, or a combination, and the tax treatment depends on the form.

Rights offerings and warrant exercises are corporate actions too, and both create new shares and dilute existing holders — which a listed call option's exercise does not.