Equity Securities Flashcards
(132 cards)
1
Q
What are the two primary types of equity securities?
A
Common and preferred stocks
2
Q
What does each share of common stock entitle its owner to?
A
A portion of the company’s profits and dividends and an equal vote on directors
3
Q
What is the role of a board of directors (BOD) in relation to common stockholders?
A
Stockholders vote to elect candidates to oversee the company’s business
4
Q
How is an individual’s common stock ownership represented?
A
As a proportionate interest in a company
5
Q
What are the classifications of common stock?
A
- Authorized
- Issued
- Outstanding
- Treasury
6
Q
What does authorized stock refer to?
A
The number of shares a company is allowed to issue as specified in its corporate charter
7
Q
What is issued stock?
A
Authorized stock that has been sold to investors
8
Q
What is the formula to calculate outstanding stock?
A
Issued stock - Treasury stock
9
Q
What is treasury stock?
A
Stock a corporation has issued and subsequently reacquired
10
Q
What rights do stockholders have regarding the company’s debts?
A
Limited liability; they cannot lose more than their investment
11
Q
What does residual claim to assets mean for common stockholders?
A
They have the last claim on corporate assets after all debts and other security holders
12
Q
What is a stock split?
A
An increase in the number of shares that reduces the price without affecting total market value
13
Q
What happens to an investor’s total value during a stock split?
A
It remains unchanged
14
Q
What is a stock dividend?
A
A dividend paid in additional shares of stock rather than cash
15
Q
What is the transferability of common stock?
A
Shares are freely transferable without issuer permission
16
Q
What voting rights do common stockholders have?
A
The right to vote on important company matters
17
Q
What are statutory and cumulative voting?
A
- Statutory voting: one vote per share for each item
- Cumulative voting: total votes can be allocated in any manner
18
Q
What is supervoting stock?
A
Stock that provides owners with a larger proportion of voting rights
19
Q
What is a proxy in the context of stockholder voting?
A
A form of absentee ballot allowing stockholders to vote without attending the meeting
20
Q
What are preemptive rights?
A
The right of stockholders to purchase additional shares before they are offered to the public
21
Q
What is the significance of inspection rights for stockholders?
A
The right to receive annual financial statements and lists of stockholders
22
Q
Fill in the blank: Common stock is known as the most ______ security.
A
junior
23
Q
True or False: Shareholders vote on dividend-related matters.
A
False
24
Q
What are the two basic forms of ownership in a company?
A
Common stock and preferred stock
25
What does preferred stock represent?
Ownership (equity) in the corporation
26
Does preferred stock typically offer appreciation potential?
No
27
What type of return is preferred stock always issued with?
A fixed (stated) rate of return
28
What is the primary reason investors purchase preferred stock?
For income
29
What is adjustable-rate preferred stock?
Preferred stock issued with a variable dividend payout
30
True or False: Preferred stockholders have voting rights.
False
31
What advantage do preferred stockholders have over common stockholders regarding dividends?
They must receive their stated dividend in full before common stockholders may receive a dividend
32
In the event of bankruptcy, who has a priority claim on assets?
Preferred stockholders
33
What is a key attraction of preferred stock for income-oriented investors?
Its fixed dividend
34
How is a preferred stock typically identified?
By its annual dividend payment stated as a percentage of its par value
35
If a preferred stock has a par value of $100 and pays $6 in annual dividends, what is its percentage?
6%
36
What happens to preferred stock prices when interest rates increase?
They decline
37
Fill in the blank: Preferred stock has _______ over common stock in the payment of dividends.
Preference
38
What is straight preferred stock?
Preferred stock with no special features beyond the stated dividend payment
39
What happens to dividends in arrears for cumulative preferred stock?
They must be paid before any common dividends
40
What is a cumulative preferred stock?
Preferred stock where skipped dividends must be paid before paying a common dividend
41
Why do cumulative preferred stocks typically have a lower stated dividend than straight preferred?
Less risk equals less reward
42
What is a convertible preferred stock?
Preferred stock that can be exchanged for shares of common stock
43
What is the impact of the convertible feature on the dividend rate of convertible preferred stocks?
It results in a lower dividend rate
44
What is participating preferred stock?
Preferred stock eligible to receive a percentage of the common dividend
45
What is callable preferred stock?
Preferred stock that can be bought back by the company at a stated price
46
What happens to callable preferred stock when it is called?
Dividend payments and conversion rights end
47
What is an adjustable-rate preferred stock?
Preferred stock with variable dividend rates based on a chosen standard
48
What is a key advantage of adjustable-rate preferred stock?
It does not have the interest rate risk of other fixed-income securities
49
What are preemptive rights?
Entitlements for existing stockholders to maintain their ownership proportion by buying newly issued shares before public offering.
## Footnote
This allows shareholders to avoid dilution of their ownership stake.
50
What is a rights offering?
An opportunity for stockholders to purchase common stock below the current market price.
## Footnote
Rights are valued separately from the stock and can trade in the secondary market.
51
Do rights pay dividends?
No, rights themselves do not pay dividends.
## Footnote
Only shares acquired through exercising rights may pay dividends.
52
What can a stockholder do with rights?
They can:
* Exercise the rights to buy stock
* Sell the rights for profit
* Let the rights expire
## Footnote
Rights certificates are negotiable securities, allowing for trading.
53
What is a subscription right?
A certificate representing the privilege to buy additional shares of a corporation.
## Footnote
One right is granted for each share of common stock owned.
54
What is the typical lifespan of subscription rights?
Generally 30–45 days, rarely more than 60 days.
## Footnote
This short lifespan necessitates timely action by stockholders.
55
What is the ex-date in a rights offering?
The first day it is too late for investors to buy the stock and get their names on the company's records.
## Footnote
It usually coincides with the record date.
56
How many rights are needed to buy one new share if a company has 10 million rights for 1 million new shares?
10 rights are needed to buy one new share.
## Footnote
This is calculated by dividing the total rights by the number of new shares.
57
What happens to the market price on the ex-date?
It typically drops by the value of the right.
## Footnote
This adjustment reflects the absence of the right to purchase new shares.
58
What is the formula to compute the value of a right before the ex-date?
(Market price − Subscription price) / (Number of rights to purchase one share + 1)
## Footnote
This formula includes an adjustment for the right's value before the ex-date.
59
What is a standby underwriter?
An investment banker who agrees to buy all shares that current stockholders do not subscribe to in a rights offering.
## Footnote
This ensures that the issuer sells all available shares.
60
What is a warrant?
A certificate granting its owner the right to purchase securities from the issuer at a specified price.
## Footnote
Warrants are long-term instruments, unlike short-term rights.
61
What distinguishes a warrant from a right?
Warrants are long-term with an exercise price higher than the market price at issuance.
## Footnote
Rights are typically short-term with an exercise price below the market price.
62
What is the typical life of a warrant?
Generally at least two years, often five years or more.
## Footnote
Some warrants can be perpetual, meaning they never expire.
63
What are American Depositary Receipts (ADRs)?
Receipts for shares of a foreign stock deposited with a custodian, representing ownership in the foreign security.
## Footnote
ADRs trade in U.S. dollars and are subject to U.S. regulations.
64
What rights do ADR owners typically have?
Most rights of common stockholders, including receiving dividends in U.S. dollars.
## Footnote
However, ADRs usually do not confer voting rights.
65
What is currency risk in the context of ADRs?
The risk that the value of the foreign currency decreases against the U.S. dollar, affecting dividend payments and stock value.
## Footnote
This risk can lead to reduced returns for ADR investors.
66
What are sponsored ADRs?
ADRs issued with the assistance of the foreign company to increase its ownership base.
## Footnote
Sponsored ADRs typically provide financial statements in English to holders.
67
True or False: Warrants provide income to their holders.
False.
## Footnote
Like rights, warrants do not pay dividends.
68
What is the primary market?
The market in which the proceeds of sales go to the issuer of the securities sold
69
What is the secondary market?
The market where previously issued securities are bought and sold
70
Which act regulates activity in the primary market?
The Securities Act of 1933
71
Which act regulates activity in the secondary market?
The Securities Exchange Act of 1934
72
What is the role of the SEC under the Securities Exchange Act of 1934?
To protect investors by regulating exchanges, broker-dealers, insider transactions, and trading activities
73
Name three major stock exchanges.
* New York Stock Exchange (NYSE)
* NYSE American
* Nasdaq
74
What is a listed security?
Any security that is bought and sold on an exchange
75
What type of securities are typically found on the NYSE?
Blue chip stocks
76
What is the primary function of a designated market maker (DMM)?
To conduct the auction on the exchange
77
What is the Over-the-Counter (OTC) market?
An interdealer network where unlisted securities trade
78
What types of securities are commonly traded OTC?
* Stocks
* Corporate bonds
* Municipal securities
* U.S. government securities
79
What is OTC Link?
An electronic interdealer quotation and trading system for the OTC Markets Group
80
True or False: OTC stocks are typically eligible for margin trading.
False
81
How do market makers operate in the OTC market?
They choose to deal in selected OTC stocks and maintain an inventory of those stocks
82
What are Electronic Communications Networks (ECNs)?
Electronic trading platforms that automatically match buy and sell orders
83
What are the regular trading hours of the NYSE?
9:30 a.m. to 4:00 p.m. ET, Monday through Friday
84
What do ECNs facilitate?
Extended-hours trading
85
What percentage of trading volume in the U.S. stock market do dark pools account for?
About 30%
86
What is a dark pool?
A private stock exchange not openly available to the public
87
What is a concern with dark pools?
Some market participants are disadvantaged because they cannot see the trades, volume, or prices
88
Fill in the blank: The bulk of trading volume in dark pools represents large trades engaged in by _______.
[institutional traders]
89
What is portfolio income?
Portfolio income includes dividends, interest, and net capital gains derived from the sale of securities.
## Footnote
Taxed in the year in which it is earned.
90
What is the main purpose of investing in preferred stock?
The main purpose is usually to receive dividends.
## Footnote
Dividends are an important source of income.
91
How are dividends on preferred stock paid?
Dividends on preferred stock are always paid in cash.
92
How may dividends on common stock be paid?
Dividends on common stock may be paid in cash or as additional shares of stock (stock dividends).
93
What is the tax rate for qualified cash dividends?
The tax rate is generally a maximum of 15%.
94
What happens if a cash dividend is nonqualified?
Ordinary income tax rates apply.
95
What should you assume about dividends from U.S. corporations for exam purposes?
Assume that any dividend from a U.S. corporation is qualified unless stated otherwise.
96
What is a stock dividend?
A stock dividend is when a corporation pays out shares of common stock rather than cash.
97
What is the IRS's stance on the taxation of stock dividends?
The IRS does not consider stock dividends taxable when paid.
98
How is the cost basis adjusted for stock dividends?
The cost basis is adjusted by dividing the original cost by the total number of shares after the dividend.
99
What are capital gains and losses?
Capital gains are profits from selling a security at a higher price than its cost; capital losses are losses from selling at a lower price.
100
What defines a short-term capital gain or loss?
A short-term capital gain or loss occurs for securities sold within 12 months of purchase.
101
What tax treatment favors long-term capital gains?
Long-term capital gains are taxed at lower rates compared to short-term gains.
102
What is the net long-term result for the investor in the example provided?
The net long-term result is a capital gain of $3,000.
103
What is the tax rate on short-term capital gains?
The tax rate is the same as ordinary income tax rates.
104
What happens if an investor has a net capital loss exceeding capital gains?
The losses can be deducted against earned income, up to a maximum of $3,000 per year.
105
What can be done with capital losses exceeding $3,000?
The excess can be carried forward indefinitely to offset capital gains in future years.
106
What happens to the status of carried forward short-term losses?
They keep their status as short-term losses.
107
What is an unrealized gain?
An unrealized gain occurs when shares have not yet been sold, resulting in no taxable gain.
108
Fill in the blank: Dividends on common stock may be paid in cash or as _______.
additional shares of stock (stock dividends).
109
True or False: All cash dividends are subject to the same tax rate regardless of their qualification.
False.
110
What is the legal definition of a penny stock?
A stock that trades for less than $5 per share and is not listed on a major exchange such as the NYSE or Nasdaq
111
What are the general risks associated with penny stocks?
They have the same risks as any other common stock and are highly speculative securities
112
Why is there a lack of transparency in penny stocks?
They trade OTC with less stringent requirements, and analyst coverage is spotty
113
What does lack of liquidity mean in the context of penny stocks?
It may be difficult to sell shares due to infrequent trading and lack of buyers at desired prices
114
What are thinly traded securities?
Securities that trade infrequently, often resulting in a large spread between buy and sell prices
115
What is the spread in penny stocks?
The difference between the bid and ask price, such as $0.54 bid and $0.65 ask
116
What is the consequence of the spread for penny stock investors?
Investors face an immediate loss if they have to sell their shares
117
What does the SEC warn about many penny stock companies?
Many are new and have little or no operating history, leading to high investment risk
118
What is a pump and dump scheme?
A fraudulent activity where rumors are spread to inflate stock prices, leading to losses for unsuspecting investors
119
True or False: Penny stocks are always traded for pennies.
False
120
Fill in the blank: Penny stocks are considered _______ securities.
highly speculative
121
What is the purpose of the special rules for penny stocks?
To protect investors due to their highly speculative nature and risks
## Footnote
The rules are found in Section 15(g) of the Securities Exchange Act.
122
What does Rule 15g-2 require before a customer can trade penny stocks?
Customers must receive a risk disclosure document and provide a signed acknowledgment
## Footnote
The firm must wait at least two business days after sending the document before executing the first trade.
123
What information must be provided to penny stock purchasers under Rule 15g-3?
A current bid and asked quote for the stock
## Footnote
This information must be given orally or in writing before any transaction.
124
What do Rules 15g-4 and 15g-5 require regarding compensation?
Members must disclose compensation information for both the member and the registered representative
## Footnote
This is to prevent excessive markups.
125
How often must members provide customer account statements according to Rule 15g-6?
Monthly statements showing the estimated market value of penny stocks
## Footnote
The typical statement frequency is quarterly.
126
What is the purpose of Rule 15g-9?
To require a suitability determination for new customers
## Footnote
The member must inquire about income, net worth, objectives, and risk tolerance.
127
What defines an established customer under the penny stock rules?
A customer who has made a nonpenny stock transaction or three unsolicited purchases of penny stocks
## Footnote
Once a customer meets these criteria, they are exempt from the suitability statement requirement.
128
What is the 5% policy also known as?
FINRA Rule 2121
## Footnote
It ensures fair treatment and reasonable rates for brokerage services.
129
True or False: The 5% policy mandates that all markups must be 5% or less.
False
## Footnote
Charges of more than 5% can be reasonable, depending on the circumstances.
130
To what types of transactions does the 5% policy apply?
Transactions in equity securities in both OTC and exchange markets
## Footnote
It does not apply to prospectus offerings.
131
Fill in the blank: The 5% policy applies to _______ and agency transactions.
[principal]
## Footnote
It applies to markups, markdowns, and commissions.
132
What types of securities are excluded from the 5% policy?
Securities sold by prospectus, such as new issues and mutual funds
## Footnote
Transactions requiring a prospectus fall outside the scope of the policy.
