Investments Ch 9

Answer 1

INTRODUCTION

• Equity securities play a significant role in the investment strategies
  of investors.
• Equities potentially provide higher returns.
• Two primary sources of return with equities are dividends and
  capital appreciation.
• Significant risks exist with equities

Answer 2

BASIC CONCEPTS OF OWNERSHIP

• Equity securities represent some form of ownership interest in a
  company.
• Holders of these shares have certain rights and benefits:
• Receive dividends
• Vote on corporate issues
• Limited liability
• Ultimate distribution of assets in the event of liquidation

Answer 3

THREE METHODS OF OWNING EQUITY
SECURITIES

Question 4

EARNINGS PER SHARE

Answer 4

EARNINGS PER SHARE

Annual profits (earnings) for companies are reported in total, but also
in terms of earnings per share of common stock.
* Earnings per share (EPS) represents the accounting profit of the
company on a per share basis.
* EPS for a company with a simple capital structure is:

             Net Income   -    Preferred Stock Dividends EPS =  - --------------------------------------------------------------------
                 Weighted  Average of Common Shares

Question 5

SIMPLE CAPITAL STRUCTURE

Answer 5

SIMPLE CAPITAL STRUCTURE

• Does not include any dilutive securities, which are securities that
  could convert into common shares and dilute the ownership of the
  current common shareholders.
• These dilutive types of securities include:
• Convertible bonds
• Convertible preferred stock
• Stock options
• Warrants

Question 6

EARNINGS PER SHARE: EXAMPLE (1 OF 2)

Answer 6

EARNINGS PER SHARE: EXAMPLE (1 OF 2)
Example: Colin Corporation (CC) had net income this year of $3,141,375 and will
pay $160,000 in preferred dividends to preferred shareholders. At the beginning
of the year, CC had 200,000 common shares outstanding. On October 1st, CC
issued another 50,000 shares of common stock. The weighted average number
of outstanding common shares equals 212,500 as follows.

EARNINGS PER SHARE: EXAMPLE (2 OF 2)

Question 7

DILUTED EPS

Answer 7

DILUTED EPS

• Public companies that have complex capital structures, which
  include potentially dilutive securities, are required to report EPS on
  a diluted basis.
• Diluted EPS takes into account what would happen if these
  convertible securities were actually converted into additional
  common shares.
• This adjustment results in a lower EPS

Question 8

DIVIDENDS

Answer 8

DIVIDENDS

When a firm generates cash flows, it generally can:
* Reinvest the cash flows into wealth increasing projects
* Pay out in the form of dividends
* Repurchase shares from existing shareholders

Question 9

PAYOUT RATIO

Answer 9

PAYOUT RATIO

• The payout ratio is the percentage of the firm’s earnings that are
  paid out as dividends.

                              Dividends per share  Payout Ratio =   ---------------------------------------
                                Earnings per Share

Question 10

PAYOUT RATIO: EXAMPLE

• Colin Corporation declares and pays a $1 common dividend (per
  share) each quarter of the year. Total annual dividends are $4 per
  share. EPS is $12.

Answer 10

PAYOUT RATIO: EXAMPLE

• Colin Corporation declares and pays a $1 common dividend (per
  share) each quarter of the year. Total annual dividends are $4 per
  share. EPS is $12.

                              Dividends per share             4 Payout Ratio =   --------------------------------------   -- ----  =   .3333%
                                Earnings per Share             12

• Colin Corporation retains 66.7% of its earnings and pays out 33.3%
  in dividends

Question 11

RETENTION RATIO

Answer 11

RETENTION RATIO

• The percent of income retained by a company is its retention ratio.

                            Net INcome   -   Dividends  Retention Ratio =  -----------------------------------------
                                      Net Income  OR

Retention Ratio = 1 - Payout Ratio

Question 12

PAYMENT OF DIVIDENDS

Dividend Payment Dates
* Dividend declaration date
* Ex-dividend date
* Record date
* Payment date

Answer 12

PAYMENT OF DIVIDENDS

Dividend Payment Dates
* Dividend declaration date
* Ex-dividend date
* Record date
* Payment date

Question 13

DIVIDEND PAYMENT DATES: EXAMPLE
A firm declares a dividend on October 25th and sets the date of record as November 5th. The ex-dividend date is November 4th, one business day before the date of record. The date of payment is set as November 11th

Answer 13

DIVIDEND PAYMENT DATES: EXAMPLE
A firm declares a dividend on October 25th and sets the date of record as November 5th. The ex-dividend date is November 4th, one business day before the date of record. The date of payment is set as November 11th

Question 14

DIVIDEND YIELD

Answer 14

DIVIDEND YIELD

• A company’s dividend yield equals the annual dividend payment
  divided by the current price of the common stock.
• Measures the income as a percentage of stock price

                      Total Annual Dividends per share  DIv Yield %  =  -----------------------------------------------------
                           Stock price per share

Answer 15

STOCK DIVIDENDS

• May be paid in addition to (or instead of) cash dividends.
• Shares or partial shares granted to shareholders based on
  ownership

Answer 16

STOCK SPLITS

STOCK SPLITS
* Increases the number of outstanding shares of stock and also
decreases the value of the stock.

• A company might declare a stock split when it perceives that its
  stock price is too high for the types of investors it seeks to attract.

REVERSE Stock Split
* Reduces the number of shares and increases the share price
proportionatel

Answer 17

EXTRAORDINARY DIVIDENDS

• Dividend payments that are issued by a company that are outside of normal dividend policy
• Paid out of cash that has been accumulated

Answer 18

DIVIDEND REINVESTMENT PLANS

(DRIPs)
* Plans offered by companies that allow investors to automatically
reinvest the dividends in the company’s stock.

Answer 19

DIVIDEND VERSUS CAPITAL APPRECIATION

• From a tax standpoint, capital gains may be preferred over dividend
  income due to the deferral of taxation.
• From a reliability and predictability standpoint, dividend income may be preferred.

Answer 20

VOTING RIGHTS

• Owners of common stock have the right to vote on corporate matters: for example, Board of directors or for certain mergers.
• Straight voting
• Cumulative voting
• Proxy voting

Answer 21

OWNERSHIP CONCEPTS

Preemptive Right

• Some companies permit owners to maintain their ownership percentage in the event of any new offering of their stock.
  Liability and Liquidation
• Corporations are separate legal entities that are responsible for all their debts and claims.

Answer 22

TYPES OF EQUITY

• Defensive Stocks
• Cyclical stocks
• Blue-chip
• Growth
• Income stocks
• Interest-sensitive
• Value stocks
• Tech stocks
• New economy
• Socially responsible/Impac

Answer 23

MARKET CAP CLASSIFICATION

• Micro cap (up to $300 million)
• Small cap ($300 million to $2 billion)
• Mid cap ($2 billion to $10 billion)
• Large cap ($10 billion and higher)

Answer 24

TREASURY AND COMMON STOCK

Treasury Stock
* Stock repurchased by a corporation from its shareholders and held
in its treasury.

Classes of Common Stock
* Firms may have more than one class of common stock.

Answer 25

SPIN-OFFS

• Management may decide to spin-off a successful division or
  subsidiary of the company.
• A spin-off occurs by distributing the shares of the subsidiary to the
  existing shareholders of the company.
• In some cases, the company that is spun off may increase in
  value relative to the parent company.
• Tend to have more freedom and autonomy to pursue growth
  strategies.

Answer 26

PREFERRED STOCK

• Has characteristics of both fixed-income investments and of equity
  securities
• Dividends are equal to a stated percentage of the par value.
• Preferred dividends are paid before dividends are paid to the
  common shareholders

Answer 27

INTERNATIONAL SECURITIES

Foreign Securities
* May provide opportunities for U.S. investors
* Greater return potential
* Generally, not as efficient markets
* Provide diversification benefits

Answer 28

AMERICAN DEPOSITARY RECEIPTS

• Certificates issued by U.S. banks that represent ownership of a
  foreign company stock. Foreign shares are held in a bank in the
  firm’s home country.
• Denominated in U.S. dollars
• Pay dividends in U.S. dollars
• Changes in currency rates affect the value of the ADR

Answer 29

INTERNATIONAL FUNDS AND ETFs

International Mutual Funds and ETFs
* Have objective of investing internationally
* Global funds invest in securities throughout the world (including the
U.S.) while foreign funds strictly invest outside the United States

Foreign Closed-End Funds (CEFs)
* Provide the same basic benefits as foreign mutual funds

Answer 30

INITIAL PUBLIC OFFERING (IPO)

• Describes a private company’s first offering of shares for sale to the
  public
• “Going public” is a phrase used to describe an IPO.
• This is a primary market transaction.
• Once public, the company’s shares will trade in the secondary market.

ADVANTAGES OF GOING PUBLIC
* Raising Capital (Cash)
* Creating Currency and Liquidity
* Creating Awareness and Credibility

DISADVANTAGES OF GOING PUBLIC
* Exposure
* Stock Prices and Shareholder Value
* Loss of Control
* Compliance and Reporting Costs

Answer 31

UNDERWRITING

• Underwriters help the issuing firm determine its financial needs and how to best raise the needed funds.
• The investment banker may assume some of the risk associated
  with selling the securities to the public.

Question 32

TYPES OF UNDERWRITING

Answer 32

TYPES OF UNDERWRITING

Type of Underwriting Risk to Issuing Company Risk to Underwrite

Answer 33

OTC Market

-Third Market
-This market is especially important when the exchange is not trading a security and for trading outside the normal operating hours of the exchange.
-Large blocks of listed stocks can be traded outside the exchange in the .

Question 34

Holly bought a stock at the margin requirement, when the stock was trading at $10. The stock paid quarterly dividends of $.25. Holly held the stock for one year and sold the stock when it was trading at $11. What was Holly’s holding period return?

10%
20%
30%
40%

Answer 34

The first key to this question is knowing that the margin requirement is 50%, which is established by the Federal Reserve. So, Holly is required to pay $10 × .50 = $5 in cash and borrow the other $5 per share to make the investment.
The question does not reference any margin interest, so it’s excluded from the calculation.
The second key to this problem is that the Purchase Price in the numerator reflects both the equity contribution of $5 per share and the $5 per share that must be repaid to the broker. The Purchase Price in the denominator only needs to reflect the $5 in equity paid.

HPR = (SP - PP +/- CF)
————————
PP

HPR = ((11 - 10) + (.25 × 4))
——————————-
(10 × .5)

HPR = 40%

Question 35

To be on a corporation’s books as a holder-of-record (and thus have a right to the next dividend payment), the investor must purchase stock:

Before the declaration date.
Before the ex-dividend date.
Between the ex-dividend date and the record date.
Three days before the payment date

Answer 35

The correct answer is B.

As of the ex-dividend date, the stock sells without right to collect the next expected dividend due.

Answer 36

ACCREDITED INVESTOR
* Earned income that exceeded $200K ($300K with spouse/spousal
equivalent) in each of the prior two years, and expects the same for the
current year
* OR has a net worth over $1 million, alone or with spouse/spousal equivalent
(excluding the value of the person’s primary residence)
* OR has the knowledge and expertise to participate in private markets
* Holders of Series 7, Series 65, and Series 82 licenses (SEC may
expand list)
* “knowledgeable employees” of a private investment fund
* LLCs with $5 million in assets
* Entity with investments (> $5 million) formed under the laws of foreign
countries that was not formed for the specific purpose of investing in
the securities offered
* “family offices” (with at least $5 million assets under mgmt.) and their
“family clients”

Question 37

Monie purchases one share of Coffee Dreams, Inc. for $58. Monie uses a margin account with a 50 percent initial margin for the purchase and is concerned about receiving a margin call. If the maintenance margin equals 35 percent, at what price would Monie receive a margin call?

A. $20.30

B. $37.70

C. $44.62

D. $53.34

Answer 37

Solution: The correct answer is C.

Monica will receive a margin call if the stock falls below $44.62, as illustrated below:

Account Value = ($58 - $29) / 1 - 0.35 = $44.6154 rounded to $44.62

• $58 per share purchase, with 50% margin = $29 per share of debt

Question 38

The date on which the current dividend no longer accompanies the stock is:

A. Holder of record date.
B. Ex-dividend date.
C. Trade-free date.
D. Declaration date.

Answer 38

B. Ex-dividend date.

Question 39

Your client, Bill Brown, is an investor in ONLY dividend paying stocks. He buys them in time to catch the dividend and then sells them. You have a stock that you have researched, Gamma Globe, and it generally pays very high dividends relative to its price. What will you advise Bill to do in regard to this stock?

Wait until the stock goes ex-dividend to make the purchase, and sell immediately thereafter.

Get in on Gamma Globe's action for the long haul, that is "buy and hold."

C . Purchase the stock before the ex-dividend date, and sell when the price has rebounded.

It doesn't matter when Bill buys it, but once purchased, Gamma Globe should be held only in preparation for almost certain subsequent price increases

Answer 39

Solution: The correct answer is C.

It is the only answer that matches the client’s express strategy. Buy and hold is not what the client wants, and purchasing prior to the ex-dividend date will ensure receiving the dividend but purchasing after the ex-dividend date will cause you to miss receiving the dividend.

Question 40

The cumulative feature on a preferred stock is best described in the following:

The preferred stock gets to cast its entire total of votes in a grouping for one seat on the board of directors if the shareholders so desire.

The preferred shareholder has the option of accruing a certain number of shares and then converting them to common stock.

If there are additional or extra dividends declared, the preferred shareholders have the right to share in the profits.

If dividends are not paid in a given cycle, they cannot be paid to anyone else until they are paid to preferred shareholders.

Answer 40

The correct answer is D.

cumulative feature on a preferred stock
If dividends are not paid in a given cycle, they cannot be paid to anyone else until they are paid to preferred shareholders.

Preferred stocks are non-voting shares.

Question 41

Averages and indexes differ from one another in that an index:

Always moves up before a corresponding average moves up, and always moves down before a corresponding average moves down.

Is of value in-and-of itself, whereas an average must be compared to a historical figure to have any meaning.

Measures the current price behavior of a group of stocks in relation to a base value set at an earlier point in time.

Is the arithmetic average price behavior of a group of stocks at a given point in time.

Answer 41

INDEX - Measures the current price behavior of a group of stocks in relation to a base value set at an earlier point in time.

Question 42

How many days prior to the date of record must an investor purchase a stock to receive a dividend?

One day.
Two days.
Three days.
Four days

Answer 42

2 days

Question 43

My margin requirements are 50% initial margin and 25% maintenance margin. I purchase a total of 200 shares at $100 per share using full margin amount for the 200 share purchase. Shortly thereafter, share prices fall to $50 per share. What will my margin call be?

$1,000
$1,500
$2,500
$5,000

Answer 43

The correct answer is C.

Required: 50 × .25 = 12.50

Actual: 50 - 50 = 0

$12.50 per share × 200 = $2,500

Question 44

Which of the following types of index calculation will most likely need adjusting for a stock split?

Answer 44

Price-weighted.

Rationale

Unlike value-weighted (also known as market weighted) and equal-weighted indexes, price-weighted indexes must adjust the divisor to account for index value changes after a constituent stock split. Market value and the company fundamentals should be unaffected by the split, so neither of the other index calculations would need to be adjusted.

Question 45

An extraordinary dividend

Answer 45

An extraordinary dividend is issued outside of the normal dividend policy. As long as a company has sufficient retained earnings, they may choose to pay an extraordinary dividend if they have excess cash on the balance sheet.

Question 46

Nedra shorted 1,000 POGA shares at a price of $50 per share 30 days ago. Ten days ago POGA paid a dividend of $0.20 per share and POGA shares are currently trading at $53. Which of the following is correct?

Answer 46

SHORT SELLING XAMPLE
Nedra will NOT receive the dividend income on the shares she shorted.

Rationale

The short seller does not own the stock.

Nedra will borrow the shares, typically from a broker, and sell them.

Any dividends paid in the interim are due to the original owner, not Nedra .

To cover her position, Nedra must buy shares in the open market and at $53 would recognize a loss.

Question 47

Jacques bought 100 shares of Acclivity at $80 per share, with an initial margin of 55%. He was charged 10% margin interest annually. Two year later he sold the stock for $105 per share. Acclivity declares and pays a dividend of $2 per share each year. What was Jacques’ holding period return?

Answer 47

50%. HOLDING PERIOD CALC : EXAMPLE

Rationale

HPR % = [(ending value - beginning value) + cash flows] – interest)
————————————————————————————-
equity invested

[($105 - $80) + $4 – ($80 x 45% x 10% x 2 years)]
————————————————————————— = 50%
($80 x 55%)

Question 48

Investors are willing to pay a premium for predictable dividends because of the informational content of ____, the desire of investors for ____, and certain ___

Answer 48

Dividends, current income, institutional considerations.

Rationale

Predictable dividends typically signal that the company is financially healthy and cash dividends reduce the uncertainty of cash flows from the investment from the investor’s point of view.

Question 49

Companies generally attempt to make a profit. When this happens, they have choices as to what to do with the positive cash flow.

Which of the following represents the two choices a company has for positive net income?

Answer 49

Pay a cash dividend and/or reinvest cash flows back into the business.

Rationale

Earnings may either be retained or paid out as dividends. Company stock is generally purchased on the open market with cash that is on the balance sheet.

Question 50

A volatile stock can be pushed sharply higher by:

Answer 50

Short covering.

Rationale

In a short sale the investor borrows shares of a stock to sell immediately, in anticipation of a price decline. At some point the position must be covered which requires that the shares be

purchased in the market and returned to the brokerage firm or investor from whom they were borrowed.

Question 51

Annabelle purchased shares of Trinity Co. stock for $45 and the price has risen to $70. Annabelle would like to ensure that if the price of Trinity Co. stock falls below $62, her shares will be sold. Which of the following will accomplish her goal?

Answer 51

A stop-loss order at 62.

Rationale

stop order will convert to a market order once the stop price is reached, ensuring that the shares will be sold. The shares may, however, be sold at a price below $62.

If her goal was to sell at a price of at least $62, she might place a stop-limit order with a stop price of, for example, $65, and a limit of $62. If the stop price of $65 is reached, it becomes a limit order and will be sold only at a price of $62 or higher.

Question 52

A ___________ index is one in which the value is determined solely based on the prices of the companies included in the index and does not take market capitalization into consideration:

Answer 52

Price-weighted index.

Question 53

Andre purchased shares of Latte, Co. for $48 using a margin account with a 50% initial margin rate and a 30% maintenance margin rate.

At what price will Andre receive a margin call?

Answer 53

$ 34.29.

Rationale

The formula to determine the price at which a margin call will occur is:
debt
MARGIN CALL = —————————————–
(1-maintenance margin rate)

  $ 48 -  $24 ----------------------  =   $34.29
        (1-.30)

Question 54

Acme, Inc. has net earnings of $2.1 billion this year. It has 700 million shares of common stock outstanding, and it paid 25 cents per share per quarter this year as a dividend.

Which of the following is correct?

Answer 54

PAYOUT RATIO equals 33.33%.

Rationale

The dividend per share equals $1.00.

The EPS equals $3.00, which is found by dividing net earnings by outstanding shares.

$ 2,100,000,000
———————– = 3
$ 700,000,000

The payout ratio = dividend per share / EPS
PAYOUT RATIO equals 33.33%.

Question 55

Which of the following types of preferred stock has a dividend that may increase as the profits of the firm increase?

Answer 55

Participating preferred stock.

Rationale

Preferred stock (also known as straight preferred stock) has a right to a fixed dividend. Preferred stock may also be cumulative and or participating. Cumulative preferred stock has the right to receive unpaid dividends that are in arrears before common shareholders receive any dividends. Participating preferred is entitled to share in profits of the company.

Question 56

The Board of Directors announces the amount and date of the next dividend on the ____ date, while the ____ date is the first date on which the purchaser of a stock is no longer entitled to the recently declared dividend.

Answer 56

Declaration, ex-dividend.

Rationale

Date of declaration is the announcement date and the ex-dividend date is the date that new stock purchasers are not entitled to the dividend.

Question 57

An investor purchased shares with a market price of $70 when the initial margin requirement was 60%. If the price increases to $92
, the investor’s return, ignoring dividends and interest, is closest to:

Answer 57

52%.

Rationale

60% x $70 = $42 out-of-pocket investment
The gain on the stock = $92 - $70 = $22
$22 gain÷$42 invested = $52.38%

( $ 92 - 70 )
—————– = .5238 = 52.38 %
$ 70 @ 60%

Question 58

Byte, Inc. had net earnings of $2.5 billion last year. It has 500 million shares of common stock outstanding, which stayed the same since last year. It paid 50 cents per share per quarter this year as a dividend payment, which is the same as last year. This year’s earnings are 20% higher than last year. Which of the following is correct for this year?

Answer 58

PAYOUT RATIO equals 33.33%.

Rationale

The dividend per share equals $2.00.

The EPS equals $5.00 last year, which is found by dividing net earnings by outstanding shares.

This year’s EPS is 20% higher or $6.00.

The payout ratio = dividend ÷ EPS.

$2.00 ÷ $6.00 = 33.33%T
PAYOUT RATIO equals 33.33%.

Question 59

All of the following are correct regarding stock splits except:

Answer 59

The tax basis in each share of stock remains the same after a stock split.

Rationale

The total basis will not change, but the tax basis in each share of stock will change after a stock split

Question 60

he stock prices of four companies are $20, $22, $27, and $28. What is the value of a price weighted index for these stocks?

Answer 60

$24.25.

Rationale

($20 + $22 + $27 + $28) ÷ 4 = $24.25.

Question 61

The dividends paid to shareholders on a regular basis are mostly referred to as:

Answer 61

A regular dividend.
Rationale

Expected cash dividends normally paid to investors are regular dividends. Stock dividends are shares of stock paid to investors in lieu of cash. Stock splits involve an increase in the number of shares outstanding. For example, a 2:1 split would double the number of shares outstanding and the price per share would be halved.

Question 62

Pablo bought shares of UNER stock at a price of $95.00 per share. He bought the shares on an initial margin of 60% paying interest on the margin loan of 5% per year. One year later, UNER stock is trading at $94.00 per share having just paid a dividend of $1.50. Which of the following is correct?

Answer 62

Pablo has a positive dividend yield.

Rationale

Although Pablo purchased the shares on the margin, he is still the legal owner of the shares and will receive the $1.50 dividend that was paid. He therefore has positive dividend yield regardless of the movement in share price. As the share price has fallen from the initial price there is no capital appreciation. Buying on the margin would increase a holding period loss or gain.

Question 63

Stock purchases with a 50% initial margin and a 30% maintenance margin will be called at a:

Answer 63

The formula used to determine the price below which a margin call will occur is: debt/(1-MMR).

For example, if a 50% initial margin rate and a 30% maintenance margin rate applies, a stock that was purchased when the price was $100 would receive a margin call if the price falls below $50÷(1-0.30) = $71.42.

The price drop is $28.58, or [1-(debt÷(1-MMR))], which is a price drop of 28.58%, [1-(0.50÷0.70) = 28.58%].

Question 64

Which of the following is not a reason that ABC Inc. would prefer to pay a STOCK DIVIDEND rather than a regular cash dividend?

Answer 64

To increase shareholder wealth.

Rationale

When a company pays out a stock dividend, it issues shares to existing shareholders in proportion to their holdings. Although the number of shares increases, the price per share will fall and in theory there should be no change in market capitalization or shareholder wealth. The drop in price per share may bring the share price down to a more acceptable price range if it has been trading too high (many investors shy away from buying stocks priced over $100).

Paying a stock dividend instead of a cash dividend does save cash that would otherwise have paid out as a dividend.

Question 65

A composite value of stocks traded on secondary markets is classified as:

Answer 65

Stock market index.

Rationale

A stock market index is a composite value of a certain group of stocks and is used as a measure of the performance of the overall market or of stocks trading on a particular exchange. The Dow Jones Industrial Average, S&P 500 index, and NASDAQ Composite index are examples of stock market indexes.

Answer 66

Margin Questions TEST

• Initial Margin: Amount of equity an investor must contribute
  to enter a margin transaction
• Maintenance Margin: The minimum amount of equity
  required before a margin call. The price at which a margin
  call occurs:

             LOAN ------------------------------------- 1 – Maintenance Margin

EXAMPLE:_______________________________ ???
Lisa purchased 100 shares of stock at $50 using her 70% margin
account. Her maintenance margin is 40%. Lisa has no other
securities in her account. At what price will Lisa receive a margin
call?
A. $7.60
B. $11.40
C. $19.00
D. $25.00

EXAMPLE :______________________________________________??
Mark purchased 100 shares of stock at a price of $32 a share. He
utilized his 60% margin account to make the purchase. His
maintenance margin is 35%.
* What is Mark’s initial equity in this investment?
* What price will Mark receive a margin call?
* How much equity is Mark required to contribute if the
stock falls to $18.00 per share?

EXAMPLE: _______________________________________
How much equity must an investor contribute?
* Example: Joe purchased 100 shares of Starbucks trading at $50 per share with an initial margin requirement of 75% and a maintenance margin of 35%. The price fell to $15 per share. How much equity must Joe contribute?

Required Equity = stock Price x Maint. Margin

Actual Equity = Stock Price - Loan Amount

Must contribute the difference between Required Equity and Actual Equity.

Answer 67

TEST

Primary vs . Secondary Markets

• Primary market is one in which new issues of securities are sold to the public
  − Public offering
  − Rights offering
  − Private placement
• Secondary Market
  − Provides liquidity for current shareholders
  − Provides continuous pricing

Answer 68

TEST

Ways to Invest Internationally

• Indirect international investments include:
  − U.S. Multinational companies and mutual funds
• Direct international investments include:
  − Buying stock of a foreign company on foreign exchanges
  − Buying stock of a foreign company on U.S. exchanges
  − American Depository Receipts
  − Yankee Bonds

Answer 69

TEST

Characteristics of selling short

Selling first at a higher price, in the hopes of purchasing the stock
back at a lower price
− Investor must have a margin account
− Investor must deposit cash or securities to cover any potential price appreciation of the stock
− Sale proceeds are held by the broker
− No limit on losses
− Dividends paid by a corporation must be covered by the
short seller

Answer 70

TEST

• Market Order
  − Timing rather than price is important (Guaranteed an execution)
• Limit Order
  − Price rather than timing is important (Guaranteed a price)
  − Limit to buy at $90, when stock is trading at $92
• Stop Order (Stop Loss)
  − Once stop price is reached, it becomes a market order: Stop sell at
  $105, when stock is trading at $110. Once the $105 price is reached,
  it becomes a market order.
• Stop Limit Order
  − Similar to Stop Order, but a limit price is also set. Stock is trading
  at $110. Stop at $105, limit at $100 (don’t sell below limit price

Answer 71

TEST

• Calculate market capitalization
• Price Weighted Averages/Indexes

DJIA
–Strong correlation with the rest of the stock market
– Does not incorporate market cap into the average
–Leading or historical indicator of the economy

Market Value Weighted Averages/Indexes
* Russell 2000 (small cap)
* S&P 500 (large cap stocks)
* S&P 400 (mid-sized stocks)

Answer 72

TEST

Market Capitalization

• Small-cap stocks
  − Market value of less than $2 billion, and may offer above-average returns.
• Mid-cap stocks
  − Medium-sized stocks, generally with market value
  range of $1 billion to $2-10 billion.
• Large-cap stocks
  − Market values more than $10 billion.

Answer 73

TEST

• Public offering
  − An offering to sell to the investing public a set number of
  shares of a firm’s stock at a specified price
• Rights offering
  − An offering of a new issue of stock to existing shareholders,
  who may purchase new shares in proportion to their current
  ownership position

Answer 74

TEST

• Stock Splits
  − Calculate new shares outstanding and stock price
• Dividend Yield Formula
  − Calculate either dividend yield, dividend per share or stock
  price

Answer 75

TEST

Exam Question (11 of 12)
ABC Stock has a P/E ratio of 15 and a dividend yield of 4%, and a
stock price of $30. What is the amount of dividends per share?
A. $1.00
B. $1.20 «< check this ??
C. $1.50
D. $2.00

                  Annual div.                    X                                  X DIV Yield =  -----------------  =   4% = --------   =     30 x .04 = ------   x   30                                       
                 Stock Price                     30                                 30   

1.20 = x

Answer 76

TEST

• Cash Dividends
  − Qualified dividends receive capital gains treatment
  − A qualified dividend:
  
  1. Paid by an American company or qualifying foreign company
  2. Not listed as a dividend that doesn’t qualify by IRS
  3. Held the stock for more than 60 days during the 121 day period
     that begins 60 days before the ex-dividend date
• Stock Dividends:
  –Not taxable to the shareholder
  –Shares or partial shares granted to shareholders based on ownership.
  – NO impact on the market value of the company in total, or the value of each individual shareholder’s holding. There has been no change in the fundamental value of the company so the increase in the number of shares in issue should result in a proportional decrease in the value per share.
• Stock Splits:
  – Increases shares outstanding and reduces stock price.
  –market capitalization remains the same
  –Tax basis in each share of stock will change proportionally after a stock dividend or a stock split. The total basis, which is the amount of money that has been invested in the stock, does not change. However, the total tax basis must be spread over a larger number of shares.

Answer 77

TEST

Ex-dividend date: The date the stock trades “without” the dividend.

To receive the dividend, an investor must purchase the stock before the ex-dividend date or 2 business days prior to the date of record

Dividend declaration date _____________________
The date when the board of directors declares a dividend payment. This action creates an obligation for the company to make a dividend payment.

Ex-dividend date -
–Set one business day before the date of record.
–Ex-dividend means that the stock trades “ex” or without the dividend distribution
–The day before the ex-dividend date is the last day the stock can be purchased in order to receive the dividend payment.
–Investors who purchase stock on the ex-dividend date or after will NOT receive the dividend payment.

Record date -
When a company declares a dividend, it sets a date of record. The date of record is the date the company determines who owns the company stock for the purpose of receiving the dividend. I

Payment date -
The date of payment is the date on which the dividend will actually be paid.

Question 78

Companies generally attempt to make a profit. When this happens, they have choices as to what to do with the positive cash flow. Which of the following represents the two choices a company has for positive net income?

Answer 78

Pay a cash dividend and/or reinvest cash flows back into the business.

Rationale

Earnings may either be retained or paid out as dividends. Company stock is generally purchased on the open market with cash that is on the balance shee