Chapter 1: Key Terms

Preferred stock features

(no) voting rights, liquidation priority (above common stockholders), and dividend payments (always pays a quarterly dividend; fixed dividend)

If a company decides to increase the size of its board of directors, who does the electing?

... the new board members are elected by shareholders, not chosen by company executives

As treasury stock increases...

...the company's outstanding share count decreases. Because treasury shares are no longer investor owned, the shares do not receive dividends or having voting rights.

How can investors who buy stocks earn a profit?

1) capital gains 2) dividends

An investor owns 200 shares of stock, currently trading at $24 per share. The company then executes a 5-for-4 split.

After the split, the investor will own 250 shares, calculated as 200 * 5/4. The new stock price is $19.20, calculated as $24/5 x 4. Notice the value of the position is $4,800 both before and after the split.

Short sales

An investor sells borrowed shares in the market, hoping to replace or "cover" the position at a lower price than the shares initially sold for; the difference between what the investor sells for and what the investor pays back is profit/loss

Ex-rights

Because new shares available through rights are sold at a discount, the rights have value and are traded separately on the open market.

Do ADR's have call risk?

Because they are common stock, the company does not have the right to redeem the shares from the investor

Who are paid last in liquidation?

Common stockholders

Relationship between preferred shares and dividends

Cumulative, convertible, and participating preferred will pay lower dividends than preferred shares that provide an advantage to the issuer - the investor is essentially trading away the higher dividend payment for the beneficial features and vice versa

In the payment of a cash dividend for a regular way transaction, the four relevant dates occur in the following order:

DERP D: declaration date E: ex-dividend date R: record date P: payable date

Form 10-K

Financial information about the company / audited financial reports; must typically be filed with the SEC within 90 days of a company's fiscal year

Rights offering

Gives shareholders the right to acquire additional shares, proportionate to their current holdings, at a stated price

Convertible preferred stock

Gives the holder the option to exchange the preferred shares for shares of the issuer's common stock according to a defined ratio that is based on par value

An investor can manage systematic risk through a process of...

Hedging with derivatives -- systematic risk can be effectively managed using various hedging strategies, such as options and futures.

Issuing stock is advantageous for a company because...

I) It does not require the company to pay back the money II) It does not require the company to make periodic interest payments

Which of the statements are correct regarding taxation of dividends?

I. Cash dividends are taxable when received IV. Stock dividends are not taxable when received

A cash dividend has been declared on ABC stock which is payable on Friday, June 20th to shareholders of record on Friday June 13th. Which of the following statements are true?

II. An investor must purchase the stock before Thursday June 12, to receive the dividend IV. An investor who purchases ABC stock on Thursday, June 12, regular way settlement, will not receive the dividend An investor must own stock as of the date of record in order to receive a dividend payment. To own stock by the record date, it must be purchased before the ex-dividend date which is 1 business days before the record date. In this example, ABC stock must be purchased no later than Wednesday June 11, as the ex-date is Thursday, June 12th. By purchasing before the ex-date, there are two business days for settlement to occur, in accordance with regular way settlement process. Stock that is purchased after the ex-date will trade ex-dividend, or without the dividend.

In the process of a dividend payment, dividends are paid to common shareholders

II. who own stock on the record date IV. only when declared by the Board of Directors A company's Board of Directors must declare a dividend payment, but shareholders do not vote on payment of dividends. Dividends are paid to stockholders who own stock as of the date of record. The ex-date represents the first day on which an individual purchases stock without being entitled to the dividend.

Shareholders have _______ liability

Limited: they are only on the hook for the amount invested and cannot lse more than their original investment

Are warrants generally issued with intrinsic value?

No - they are issued with an exercise price above the current market price of the stock. They are not valuable until the stock's price increases.

Where are penny stocks sold?

OTC (over the counter marketplace) and are quoted on the OTC Bulletin Board or OTC Market

Adjustable-rate preferred stock

Pays dividends that are determined based on an underlying benchmark - usually the US Treasury bill

Pre-emptive rights

Preferential rights given to existing shareholders to purchase shares of new stock issue; preference given in proportion to percentage of stock shareholder already owns; give investors the right to maintain a proportionate interest in a company's stock, not increase it

Participating preferred stock

Preferred stock that shares with common stockholders any dividends paid in excess of the percent stated on preferred stock.

Exercise price for rights and warrants

Rights: below the current market value Warrants: above the current market value

Timeframe for rights and warrants

Rights: short-term Warrants: long-term

Preferred stock trades most like which of the following instruments?

Straight debt security -- because of the fixed dividend payment, preferred shares are influences in the market by the same factors that impact straight debt securities. Like bonds, there is an inverse relationship between price and interest rates.

Regular way

T+2 Most equity trade settle this way; two business days after the trade date

Calculating stock splits

To calculate the new number of shares after a split, multiply the shares by the first number of the split and divide by the second. Example: ABC declares 20% stock dividend, meaning that an investor will receive one new share for every five shares held. Instead of holding 100 shares at $30, the investor now has 120 shares at $25. The total value of the position remains $3,000 (120 * $25)

Do warrants or rights typically remain outstanding longer?

Warrants

Dividends

a share of the corporation's profits; if they are to be paid, a specified amount if allocated for each outstanding share

Cumulative voting

allows the shareholder to pool votes together and then allocate them as desired

Statutory voting

allows the shareholder to vote one time per share for each seat on the board of directors

Stock split

an adjustment in an issuer's outstanding share count; after, each investor's ownership position remains unchanged, but the number of shares and the stock price are adjusted

Liquidation

bankruptcy

Callable preferred stock

can be repurchased by the issuing company at its discretion; if called, the investor is required to sell them back to the issuer

Non-systematic / non-systemic risk / business risk

changes in corporate management or product recalls are examples

Declaration date

date on which the board of directors declares that a dividend will be paid

Warrant

entitles the holder to buy the issuer's stock at a specified price for a period of time

Common stock

equity security that represents ownership, giving investors a claim on the company's assets and earnings, and offering the potential for growth (capital gains) and/or income (dividends)

Why do investors purchase penny stocks?

goal of capital appreciation; because of their low stock price and general lack of liquidity, penny stocks are considered extremely risky securities

Cumulative preferred stock

includes a provision that gives shareholders the right to receive dividends in arrears - i.e., these holders must receive dividends for both the current period and any previously skipped dividends before a dividend payment can be made to common stockholders

Reverse split

increases the price of the stock and converts each position into proportionately fewer shares; may increase the marketability of a stock, as the stock will no longer carry the perception of being a low-priced stock

Rights and warrants may trade as ________ securities in the __________ market.

independent; secondary

Blue chip stocks

issues of well-known companies - often large in size; because of their size, they offer modest growth potential but produce steady income stream because they pay a consistent dividend

Registrar

maintains records of ownership of securities by matching each share of stock against an ownership record and ensuring there is no unauthorized issuance

Cyclical stocks

mirror the economy; ex. include companies that supply capital equipment for businesses or high-ticket consumer items (i.e., cars and large appliances)

Dividend in arrears

missed dividend payments; preferred stockholders will receive at least the par value of their shares and dividend in arrears before common stockholders receive anything

Treasury stock

not included when calcualting a company's total outstanding share

Negotiable security

one that can be freely transferred, assigned, or delivered to another entity

Shareholder

owner of the company's common stock

Stock dividends

paid in extra shares of stock instead of cash

Risks of owning ADRs

political risk, currency risk, inflationary risk

Income stocks

produce income, typically in the form of dividends; utility stocks

Transfer agent

records changes of ownership in securities and may maintain records of ownership

Market risk / systematic risk / systemic risk

reflects the fact that the performance of an individual security will be impacted by the overall market

American depositary receipts (ADRs)

represent ownership in the shares of non-US companies that trade in US financial markets; these shares are referred to as ADS

Defensive stocks

resistant to changes in economic cycles; examples are utility stocks, stocks of staple consumer items, and stocks of discount retailers like Wal-Mart

Diversification

risk-management technique that mixes a wide variety of investments within a portfolio

Cash settlement

same-day payment, same-day settlement

Treasury shares

shares issued to investors and repurchased by the company

Forward stock split

stock split when the shareholder receives additional shares; generally occur when a company believes its share price is to high to interest potential buyers

Growth stocks

stocks of companies that reinvest most of their earnings into their businesses

Capital gains

the buying of stock at one price and selling it at a higher price

Payable date

the date payment is actually made (generally about three weeks after the record date)

Ex-dividend date

the date two business days before the date of record, establishing those individuals entitled to a dividend

Record date

the date upon which a stockholder must be a registered owner of the stock to receive the dividend

Cash dividends

the most common type of dividend; those paid in cash

Issued stock / Otustanding shares

the shares of authorized stock that are sold to the public

Why do investors engage in short sales?

they wish to speculate that the price of securities will fall

Penny stock

unlisted stock trading for less than $5 per share

Authorized stock

when a company decides to offer stock to the public; approved set of shares

Settlement

when legal title passes from seller to buyer and the stock trade is complete