Introduction
In preparing for the FINRA Series 7 exam, it is crucial to have a solid understanding of key financial terms. Appendix B: Glossary of Terms provides you with a comprehensive guide to terms starting with the letter “D,” such as “Derivative,” “Discretionary Account,” and “Diversification.” Mastering these terms will enhance your knowledge and support your success in the exam.
Body
Derivative
A Derivative is a complex financial security whose price is dependent upon or derived from one or more underlying assets. Its value is determined by fluctuations in the underlying asset, which could include stocks, bonds, currencies, interest rates, or market indexes. Common derivatives include futures contracts, options, and swaps. Understanding how derivatives work is critical for executing sophisticated trading strategies and hedging risk.
Discretionary Account
A Discretionary Account is a type of investment account where a client grants a broker or financial advisor the authority to make purchase and sale decisions without requiring client approval for each transaction. This arrangement can provide flexibility and timely execution of trades, leveraging the expertise of the representative. However, it also requires a high level of trust and understanding between the client and the advisor.
Diversification
Diversification is a fundamental concept in investment management, aimed at reducing risk by investing in a variety of assets. By spreading investments across different sectors, geographical areas, and asset classes, diversification minimizes the impact of poor performance in any single investment. This strategy plays a crucial role in achieving long-term financial stability and growth.
Conclusion
Understanding terms like Derivative, Discretionary Account, and Diversification is essential for passing the FINRA Series 7 exam. These concepts form the foundation of financial securities and investment strategies, allowing general securities representatives to make informed decisions and provide valuable guidance to clients.
Supplementary Materials
Glossary
- Derivative: A financial instrument whose value is derived from the performance of underlying assets, interest rates, or indices.
- Discretionary Account: An account where the client has given written authorization to a representative to make trading decisions on their behalf, including the selection of specific securities and timing.
- Diversification: A risk management technique involving the mix of various investments within a portfolio to reduce exposure to any single asset or risk.
Additional Resources
- FINRA’s official website for in-depth resources
- Investopedia for extended definitions and examples
- Bloomberg for the latest market trends
### What is a Derivative?
- [x] A financial instrument whose value is based on underlying assets
- [ ] A direct ownership in the underlying asset
- [ ] A financial report of a company's performance
- [ ] A type of government bond
> **Explanation:** A Derivative is a financial instrument whose value is derived from the performance of assets such as stocks or indices.
### What does a Discretionary Account allow a broker to do?
- [x] Make trades on behalf of a client without prior approval
- [ ] Only recommend trades to a client
- [x] Execute trades based on verbal approval only
- [ ] Withdraw funds from a client's bank account
> **Explanation:** A Discretionary Account allows a broker to make trading decisions and execute them without obtaining prior approval from the client, although terms can vary slightly.
### Why is Diversification important in investing?
- [x] It reduces the impact of poor performance by spreading risk
- [ ] It guarantees investment returns
- [ ] It ensures a portfolio contains only low-risk assets
- [ ] It eliminates the need for financial advice
> **Explanation:** Diversification reduces risk by investing in various assets, thus minimizing the impact of a single poor-performing investment.
### Which is an example of a derivative?
- [x] A futures contract
- [ ] A common stock
- [ ] A mutual fund
- [ ] A treasury bond
> **Explanation:** A futures contract is a type of derivative as its value depends on an underlying asset.
### What is a key feature of discretionary accounts?
- [x] They require written authorization for trading decisions
- [ ] They are immune to market fluctuations
- [x] They can only be used by corporate clients
- [ ] They are limited to cash transactions
> **Explanation:** Discretionary accounts allow brokers to make decisions on behalf of clients, based on written authorization.
### Diversification is a part of which investment strategy?
- [x] Risk management
- [ ] Tax avoidance
- [ ] High-frequency trading
- [ ] Insider trading
> **Explanation:** Diversification is a core component of risk management strategies in investing.
### How does a derivative gain its value?
- [x] From the performance of the underlying asset
- [ ] From the issuing company's reputation
- [x] Solely from investor sentiment
- [ ] From fixed interest rates
> **Explanation:** The value of a derivative is derived from the price fluctuations of an underlying asset.
### Can a discretionary account be managed without client interaction after set up?
- [x] Yes, but within the agreed parameters
- [ ] No, it requires constant client input
- [ ] No, it is a self-directed account
- [ ] Yes, without any limits
> **Explanation:** A discretionary account allows a broker to manage it within agreed-upon parameters, thus requiring less frequent client interaction.
### Is diversification a guarantee against losses?
- [x] False
- [ ] True
> **Explanation:** While diversification minimizes risk, it does not eliminate the possibility of losses.
### Derivatives can be used for which of the following purposes?
- [x] Hedging risk
- [ ] Ensuring profits
- [ ] Bypassing regulations
- [x] Speculating on future asset prices
> **Explanation:** Derivatives are used for hedging risk and speculating based on asset price movements.
This guide should prepare you for questions involving these critical concepts on the FINRA Series 7 exam. Use the provided glossary for quick reference, and utilize the resources to deepen your understanding.