Series 3 Test Breakdown

The Series 3 license, otherwise known as the National Commodity Futures Examination, is required of a person to be able to sell commodities, future contracts, options, and hedging. These types of securities are considered to be the riskiest types of investments; therefore, a separate exam is required to determine eligibility to sell these instruments. This very complex exam is not provided often, and the requirements to take the exam and registration process are equally as daunting. There are two parts to the Series 3 exam; the first part has eighty-five questions on market knowledge, and the second part has thirty-five questions on regulations.

Part 1 of the Series 3 tests competencies in the futures market and futures contracts. It also tests an individual's knowledge in hedging and speculative theory and terminology. Knowledge of margin requirements, price limits, and types of orders and accounts are required. Basic hedging, calculations, spreading, and options are provided on the Series 3 test. Part 2 of the test covers topics such as commodity pool operator (CPO)/commodity trading advisor (CTA) regulations, arbitration procedures, and the Commodity Futures Trading Commission (CFTC) Commodity Exchange Act Enforcement. The test taker should be very familiar and knowledgeable with all aspects of commodity regulations and futures trading to be successful on this test.

The testing time for the Series 3 is two and a half hours, and it consists of 120 multiple-choice questions. The cost for the exam is $115, and the test taker must be sponsored by a Financial Industry Regulatory Authority (FINRA) firm. Besides this examination fee, other licensing fees may also apply. The Series 3 is administered by FINRA, which some people might remember as the National Association of Securities Dealers (NASD). This multiple-choice test is administered any day of the week at sites across the United States as well as internationally. A 70% passing score is required on both parts of the exam. In addition, many agents take the Series 31, which allows the selling of managed futures, which are part of a mutual fund portfolio.

In some instances, a person may not be permitted to take the Series 3 exam but may be allowed to sit for other exams. Before registering for the test, test takers should check the National Futures Association (NFA) Web site for proficiency requirements. In addition, exemptions may be permitted for some individuals, depending on the business of the firm. The NFA was established to help answer broker questions and to safeguard market integrity and protect investors industrywide.

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Series 3 Study Guide

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Series 3 Practice Questions

1. Which consideration helps determine the initial margin amount a trader must deposit with a clearinghouse?

a. The equity acquired from purchases from the account
b. The type of commodities purchased
c. The dollar amount of the first trade
d. The frequency of trading activity in the account

2. Which of the following is not a service that a commodities clearinghouse provides to commodities traders?

a. Guarantees those commodities contracts will be fulfilled
b. Provides liquidity to commodities markets
c. Sets margin requirements
d. Confirms and verifies commodities trades prior to execution

3. Which strategy do investors use to minimize risk in the futures exchange markets?

a. Margin
b. Hedging
c. Forward contracts
d. Risk transfer

4. Which condition in the commodities markets helps to provide liquidity and stabilize prices?

a. Increase in the number of speculators
b. Undersupply of a commodity and decreased demand
c. Decrease in hedging
d. The underlying commodity

5. What characteristic is shared by both a long hedge and a short hedge?

a. Protection when offsetting a short position
b. Protection when offsetting a long position
c. Protection against delivery of a commodity
d. Protection against price fluctuations

Answers and Explanations

1. C: The dollar amount of the first trade. Margin is the amount of money an investor must deposit with a clearinghouse before executing a trade. The margin amount is set by the clearinghouse and may be different for each type of commodity. The initial margin deposit allows the trader to begin trading on the commodities exchange offering a particular commodities contract. After the initial deposit is made, a number of scenarios may occur; the first trade may not use all of the deposited funds, the trader may deposit other moneys in the account to support additional purchases from the same account, and when a trade results in a loss, the trader is obligated to make additional deposits to meet the minimum initial margin requirements.

2. C: Sets margin requirements for investors. Margin deposits are required of investors in order to guarantee that the buyer of a commodity doesn't default on a contract. The exchange and the clearinghouse, working in conjunction with each other, set the margin at a certain percentage of the commodity unit. The initial margin deposit must be enough to cover the clearinghouse position and the exchange where the trades occur. The clearinghouse is central to the transactions between buyer and seller because they maintain funds used to guarantee the fulfillment (but not delivery) of contracts, and they confirm and verify all trades on the exchange by the floor broker before accepting any positions. Clearinghouses provide liquidity to the markets, freeing buyers and sellers from having to individually locate and transact business across a wide range of individuals.

3. B: Hedging. Futures exchanges provide an avenue for commodities buyers and speculators to minimize their risks by hedging. Margin is the amount of money a trader must deposit in his account before trading any commodities. The minimum amount of the margin deposit is set by the particular exchange trading in a commodity. A forward contract is a deferred cash market trade in a particular commodity. A forward contract is not made through an exchange; the arrangement is between the producer of a commodity and the buyer of a commodity. Risk transfer is used to protect or hedge against price increases. When an investor wishes to secure a specified amount of a commodity at a future date and at a predetermined price, the investor may invest in the commodity by buying a futures contract from a brokerage firm. The investor is transferring risk to another party, a speculator, who may have positions in both ends of the particular market.

4. A: Increase in the number of speculators. Speculators in the commodities market create a more stable pricing environment. Speculators often invest and take profits on smaller price movements. Along with creating demand, speculators put downward pressure on prices by selling. The oversupply of a commodity and a weakening demand result in declining prices. As speculators take advantage of declining prices, prices will stabilize. Speculation also creates liquidity, allowing buyers and sellers to offset positions according to market conditions. Offsetting positions, or hedging, provides stability to the pricing environment.

5. D: Protection against price fluctuations. A short hedge in the commodities market protects the assets of a commodity holder from adverse price movements. When a farmer wants to be guaranteed a specific price for a crop, the farmer sells a futures contract with a specific price, quality, quantity, and delivery date. When the user of a commodity, such as a manufacturer, wants a guarantee of the future delivery of a commodity, the user will take a long hedge by purchasing a futures contract for delivery of a commodity. The long hedger protects against price increases by purchasing the commodity at a known price, quality, and quantity and delivery date.


Last Updated: 04/18/2018

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