Chapter 4: Mastery Progress Exam

A convertible preferred stock is convertible at $10, pays a 4% annual dividend, is callable at $110, and is trading at a current market price of $116. Based on these details, what is the parity price of the common stock?

$11.60

A corporation has a 9% cumulative preferred stock issue outstanding. The company paid a $7 dividend two years ago and $8 last year. If the company wants to pay a common stock dividend in the current year, the cumulative preferred stockholders must first receive a dividend of:

$12 - If a common dividend is to be paid in the current year, the cumulative preferred stockholders must first receive $12 ($2 missed from two years ago plus $1 missed from last year plus the full $9 for the current year).

Ralph Generous has a cost basis of $15 per share in the Spartan Growth Fund, which has a current NAV of $27. Mr. Generous gives his fund holdings to his daughter and she sells the fund at $32. The gain upon the sale is:

$17 The daughter has a gain of $17 upon the sale of the Spartan Growth Fund because she assumed her father's basis of $15 when the gift was given.

An individual purchased 100 shares of stock at $35 per share. The stock is now trading at $44 per share and the issuer decides to split the stock 2-for-1. After the split, the individual's cost basis per share will be:

$17.50 A stock split or dividend results in an adjustment in the number of outstanding shares. As a result, the current market value is adjusted to reflect the increase or decrease in shares. The same change would be made to the cost basis of all positions held by investors. A 2-for-1 stock split results in twice as many shares, with the values being adjusted to 1/2 of what they were before the split. The individual's stock would have an adjusted cost basis of $17.50 = $35 x 1/2.

An investor buys 200 shares of TDX at $20 per share. TDX declares a 10% stock dividend. The investor's cost basis per share for tax purposes would be:

$18.18 An investor's cost basis must be adjusted downward upon receiving additional shares when a stock dividend is paid. In this example, the investor receives 20 additional shares (10% x 200). The investor's new cost basis per share would be found by dividing the initial cost of $4,000 by the total number of shares now owned (220). This equals a cost basis per share of $18.18.

A brokerage customer is long 100 shares of ABC Company 6% cumulative preferred stock ($100 par). Over the last three years, ABC Company has had negative net income and the customer hasn't received any dividends during that period. How much must the customer receive in dividend income this year before common stockholders can receive a cash dividend?

$2,400 Although the stated dividend is 6%, the board of directors for ABC Company must decide whether to declare it. Without sufficient earnings for the previous three years, the dividend could not be paid and, therefore, no common dividends were paid during the same period. Currently, there's $1,800 (6% x $100 par x 100 preferred shares x three years) of preferred dividends in arrears that must be paid to this customer before a dividend can be paid to common shareholders. Also, the $600 that the customer will need to be paid for the current year must be added to the $1,800 from past years. As a result, $2,400 must be paid to the customer before a common dividend can be paid.

An investor owns convertible preferred stock that was originally purchased at $106. The stock is convertible at $25 and has a current market price of $112. If the common stock is currently trading at $27.75 and the investor decides to convert the preferred stock into common stock, the cost basis per share for the newly acquired common stock is:

$26.50 To determine the cost basis of the common stock, the first step is to calculate the conversion ratio (i.e., the number of common shares to be received if the preferred stock is converted). The formula for calculating conversion ratio is the par value of the preferred stock ($100) divided by the conversion price ($25). As a result, four shares of common stock are received if the preferred stock is converted into common stock. The cost basis of the newly acquired common shares is found by dividing the original purchase price of the preferred stock ($106) by the number of shares received (4) ($106 ÷ 4 = $26.50). Any future gains or losses on the sale of the common stock will be calculated by using the basis of $26.50.

A client has inherited stock from a relative. The relative had originally purchased the stock at $11 per share, which had a current market value of $46 per share at the time of the inheritance. If the client sells that stock at some later date for $50 per share, what cost basis will be used to determine the gain or loss?

$46

A company has a noncumulative preferred stock outstanding that pays a $5 dividend per year. If dividends on the preferred stock were not paid last year, but will be paid this year, how much will the preferred stockholder receive?

$5

An individual received $500 in dividends from the common shares that she owns of an oil company. How much of this dividend income is subject to taxation?

$500 Under current tax law, all cash dividends that individuals receive are fully taxable.

On June 5, 2013, an investor purchased 100 shares of ABC at 20. On November 10, 2013, he purchased an additional 100 shares of ABC at 12. On January 20, 2014, he sold 100 shares of ABC at 15. For tax purposes, he would have reported a:

$500 capital loss in 2014

On February 22, an investor sells ABC stock at $31 for a 3-point loss. On March 10, the investor purchases ABC stock at a price of $27. For tax purposes, the investor's cost basis for the stock purchased on March 10 is:

30 When the wash sale rule is activated, the investor must add the loss to the new cost of the stock regardless of whether the stock is repurchased at a price that is higher or lower than the original cost. In this example, the investor's cost basis for tax purposes is found by adding the 3-point loss to the new cost of $27.

Aglet International, Inc. has pretax income of $2,000,000. In addition, it received dividends of $100,000 from the common stock of a corporation in which it had a 10% interest. If the corporation pays a 34% tax rate, what is its total tax liability?

$697,000 If a corporation owns less than 20% of the distributing company, the corporation is required to pay tax on 50% of the dividends it receives on stock that it owns (remaining 50% is excluded). The company would need to add $50,000 (50% of $100,000) to its taxable income. The total taxable income, therefore, is $2,050,000. The tax liability is $697,000 ($2,050,000 times 34% tax rate). If the corporation owned at least 20% of the distributing company, only 35% of the dividends would be taxable (65% is excluded).

A customer wishes to establish a tax loss and sells 100 shares of XYZ Corporation. The loss would not be allowed if the customer, within 30 days:

Bought an XYZ Corporation call The IRS will not allow the loss if the same security or any security convertible into the same security is repurchased within 30 days of the sale. The customer must wait until the 31st day to buy back the security or its equivalent. In this example, the only choice given that could be converted into 100 shares of XYZ Corporation would be a call on XYZ Corporation. The loss would not be allowed if the customer, within 30 days, bought an XYZ Corporation call. This is known as a wash sale.

Series K preferred stock is suitable for which of the following investors?

An investor who is seeking a high fixed dividend for a period of time followed by a floating rate dividend

A stock's price has risen due to an overall market increase. This increase in price is considered:

An unrealized capital gain

Which of the following choices does NOT require a broker-dealer to make a change in the cost basis of stock held in a customer's account?

A cash dividend

On February 13, an investor sold 700 shares of ABC stock for a loss. On the next day, the investor purchased 3 ABC February calls. Which of the following statements is TRUE?

A portion of the loss from the sale of the stock will be disallowed The wash sale rule states that all (or part) of a loss will be disallowed if the same (or substantially the same) security is purchased within 30 days (before and after) of the sale. The purchase of a call option on a security is considered substantially the same as the security, thus causing a wash sale. In this question, the purchase of 3 call options will disallow the loss on 300 of the 700 shares that were sold for a loss on February 13.

A notice is published stating that RMO 5% convertible preferred stock will be called at $60 per share. The preferred is convertible into 1/2 share of common and is selling in the market at $56 per share. RMO common stock is selling in the market at $110 per share. After the notice appears, the price of the preferred stock will most likely trade in the market at:

A price near $60 Converting the preferred stock has a value of $55 ($110 per common share x 1/2 conversion ratio). Since the call price of $60 is more beneficial to the preferred stockholder, the market price of the preferred stock will most likely rise to near $60 (the call price).

For each penny stock transaction, a broker-dealer must provide the customer with all of the following items, EXCEPT:

A risk disclosure document on penny stocks A broker-dealer must provide the customer with a risk disclosure document on penny stocks once, prior to effecting the first transaction for the customer. The other items must be disclosed in connection with each transaction.

The combination of two companies into one company is accomplished with all of the following, EXCEPT:

A spinoff

The separation of a division or subsidiary from its parent to create a new corporate entity is considered:

A spinoff

An established customer has purchased penny stocks through a broker-dealer on five occasions. When making future recommendations to the customer regarding these securities, the broker-dealer must:

Be sure that the recommendations take into account the customer's investment objectives

Junius Arbor purchased stock in 2002 for $24,000. In April 20XX, Mr. Arbor passed away. His estate valued the stock at $82,000. The stock was willed in equal amounts to his daughter Cathy and his son Bob. Cathy sold her stock on September 2, 20XX for $48,000. Bob sold his stock on May 8, 20XX for $56,000. Which of the following statements is TRUE?

Cathy has a long-term gain of $7,000 and Bob has long-term gain of $15,000 In the case of inherited securities, the value of the securities is determined at the time of death. The heirs are always considered to have long-term holding periods. The capital gains or losses for Bob and Cathy are found as follows: The securities at the time of death were valued at $82,000. Bob and Cathy were willed equal amounts of $41,000 each, establishing a cost basis for both of $41,000. To determine the gain, compare the cost basis to the sales proceeds. Cathy sold her stock for $48,000, creating a $7,000 gain, while Bob sold his stock for $56,000, creating a $15,000 gain.

ABC Corporation has issued a call notice on its 5% convertible preferred stock. The preferred stock, which is convertible at $20, is being called at $110 and is currently trading at $111. If ABC's common stock is currently trading at $23, what should an RR recommend to an investor who holds the preferred stock?

Convert the preferred stock into common stock and sell the common stock

An investor wants to buy a foreign stock that's trading at $540 per share and paying a $12.50 annual dividend. The investor's registered representative instead suggests purchasing an ADR which represents 10% of the value of the foreign stock. If the customer commits to buying 500 shares, what's his cost basis and his first semiannual dividend from the ADR?

Cost basis of $27,000 and $312.50 in semiannual dividends The ADR represents 10% of the foreign stock's value. As a result, the ADR per share value is $54 ($540 x 10%) and the annual dividend is $1.25 ($12.50 x 10%). If the customer purchases 500 shares of the ADR, the total investment will equal $27,000 (500 x $54) and the total annual dividend will be $625 (500 x $1.25). However, since the question asks about the semiannual dividend, the customer will receive $312.50 of dividends ($625 ÷ 2). Many foreign stocks and ADRs pay semiannual dividends rather than quarterly dividends.

Which of the following statements is NOT a characteristic of an electronic communication network (ECN)?

ECNs act as market makers

Which TWO of the following statements are TRUE concerning the characteristics of preferred stock? I. The securities do not have a fixed maturity date II. The price of these securities is more volatile than common stock III. The dividend will be paid annually IV. The price will fluctuate based primarily on changes in interest rates

I and IV Most preferred stock does not have a maturity date and, therefore, one of the risks of purchasing this type of security is that there is no fixed date when you will receive your principal back. These securities are less volatile than common stock, and the prices of preferred stocks are inversely related to the movement of interest rates, as are bonds. The dividend usually is paid quarterly, not annually.

Which of the following shares would be paid a dividend if the common stock were paid a dividend? I. Cumulative preferred II. Convertible preferred III. Participating preferred

I, II, and III

ABC Corporation has issued a new cumulative, convertible preferred stock. The provisions of the new issue provide for which TWO of the following choices? I. Dividends would be paid on the preferred stock after any dividends are allowed to be paid on the common stock II. Omitted dividends will accumulate and must be paid before any dividends are allowed to be paid on the common stock III. The stock may be converted into common stock at any time by the preferred stockholder IV. ABC Corporation may call the stock at its par value before the call protection period has expired

II and III

Which TWO of the following securities will MOST likely be subject to a withholding tax? I. A bond issued by a U.S. company but sold to U.S. investors II. A bond issued by a foreign company but sold to U.S. investors III. Stock issued by a foreign company but sold to U.S. investors IV. Stock issued by a U.S. company but sold to U.S. investors

II and III

A client owns 3,000 shares of stock in a company headquartered outside the U.S. The client receives a cash dividend and tax is withheld by the country where the company is located. Which TWO of the following statements are TRUE concerning the U.S. tax implications for the client? I. The dividend received is treated as a return of capital II. The taxes paid may be used as a credit III. The dividend paid is exempt from taxes IV. The taxes paid may be used as a deduction

II and IV

One of your investment banking clients has a significant amount of cash on hand. The client has sought your firm's advice regarding income-producing equity investments. Which TWO of the following investments pay a dividend but are NOT eligible for the corporate dividend exclusion? I. Common stock II. A money-market fund III. Preferred stock IV. A real estate investment trust

II and IV

Which TWO of the following securities would be MOST suitable if interest rates are expected to rise? I. Collateralized Mortgage Obligations II. A bond with short-term maturities III. Preferred stock with a fixed dividend IV. Adjustable-rate preferred stock

II and IV If interest rates are expected to rise, the most suitable investments would be those that can be reinvested quickly to take advantage of rising rates, or variable or adjustable-rate securities. Bonds with short-term maturities can be reinvested in bonds quickly with higher rates, and the dividend on adjustment-rate preferred stock would increase since the dividend paid is based on LIBOR or another rate that quickly reacts to changing interest rates.

An investor wishes to establish a tax loss but still wants to own the same security. The customer sells the security and repurchases it two weeks later. The tax loss is:

Disallowed

A special disclosure document may be required for investing in:

Penny stocks

Ms. Jones reads in the newspaper that XYZ Corporation intends to issue new shares through a rights offering. The terms of the rights offering are as follows: I. 10 rights plus $10.50 are required to subscribe to one new share of stock II. Fractional shares become whole shares III. The record date is Friday, October 17 IV. JPMorgan Chase and Bank of America are the transfer agents V. Goldman Sachs and Morgan Stanley are the standby underwriters If Ms. Jones currently owns 87 shares of the preferred stock of the XYZ Corporation, how many additional shares can she subscribe to and at what cost?

Preferred stockholders are not permitted to participate in a rights offering Preferred stockholders are not permitted to participate in a rights offering. Pre-emptive rights are only made available to common stockholders. By participating in rights offerings, common stockholders are able to maintain their percentage of ownership.

Which of the following is NOT a characteristic of preferred stock?

It carries voting rights

How would preferred stock most likely be affected by an increase in interest rates?

Its market value would decrease

Rule 145 applies to a(n):

Merger or acquisition

If an investor is anticipating that a company will have very high earnings in the current year, which of the following types of preferred stock is the most suitable?

Participating Participating preferred stock allows the owners to share in the extraordinary earnings of a company. Essentially, participating preferred has a stated dividend, but these stockholders may receive more than the stated amount based on the profits of the issuing company. In contrast, the benefit of cumulative preferred stock is that, if the issuer intends to pay its common stockholders a cash dividend after having not paid dividends, it allows the owner to add up all of the unpaid dividends to a future payment. Cumulative preferred stock may be beneficial during a period in which the company is unable to pay the full dividend since the owner is able to accrue the missing payments. Convertible preferred can be converted into a fixed number of common shares of the same issuer and tends to perform better when the market price of the common stock is appreciating. Lastly, non-cumulative preferred stock is limited to simply paying its stated dividend.

The federal securities regulation that provides rules for the secondary market is:

The Securities Exchange Act of 1934

For which of the following circumstances is there a required tax payment?

Realized gain Taxes are paid on realized capital gains; however, unrealized capital gains or losses (paper profits or losses) have no impact on the investor's tax situation. Capital or realized gains are generated when an investment is sold for a greater value than its cost basis. Return of capital occurs when an investor receives a portion of her original investment back. Since this return is not considered either income or a capital gain, it's not a taxable event.

A corporation intends to raise additional funds from its existing shareholders rather than use the services of an underwriter. The corporation is engaging in a:

Rights offering The corporation is engaging in a rights offering. It will issue rights to all existing shareholders enabling them to subscribe to new stock below the current market price of the outstanding securities, thereby saving the corporation the costs involved in using an underwriter.

An investor has made the following purchases of XAM stock: *Shares bought at $39 in May 2013 *Shares bought at $56 in September 2013 *Shares bought at $36 in January 2014 *Shares bought at $36 in June 2014 The investor sells some of his XAM shares in March 2015 at $51. Based on the various purchases, which shares may be sold to result in the greatest gain with the lowest tax liability?

Sell from the shares that were purchased in January 2014

The method of voting which gives stockholders with substantial holdings a greater degree of voting power over those stockholders who own fewer is:

Statutory voting

An individual purchases 600 shares of BAZ common stock. One week later the stock pays a dividend of $1.20 per share and the investor sells the stock the next day. For tax purposes, how will the dividends be taxed?

The dividend will be taxed as ordinary income.

A corporation is voting on several new directors. A customer who cannot attend the meeting to vote in person:

Will receive a proxy to vote, or sign over the vote to another person

All of the following are characteristics of sponsored ADRs, EXCEPT:

They have no currency risk.

Harriet purchased 1,000 shares of the Overseas Growth Fund several years ago for $9 per share. The shares are now worth $22.50 each. Harriet gives the shares to her nephew Bob as a college graduation present. What is Bob's cost basis for the shares?

$9 In general, the cost basis of gifted shares is equal to the donor's basis at the time of the gift. In this case, Harriet's basis is $9 per share, so this becomes Bob's basis as well. Note that the rule related to inherited shares is different. The basis of inherited shares is generally the value of the shares at the time of the decedent's death.

Windsor Corporation has 7,000,000 shares of common stock ($.01 par value) authorized, of which 5,000,000 shares have been issued. There are 500,000 shares of treasury stock. The current market price is $20. The market capitalization of Windsor Corporation's common stock is:

$90,000,000 Market capitalization is determined by multiplying the number of outstanding shares by the current market price per share. Outstanding shares include those held by institutions, retail investors, and restricted shares held by insiders, but does not include treasury stock (shares repurchased by the company). Therefore, there are 4,500,000 shares outstanding at a $20.00 market price for a total of $90,000,000.

XYZ Corporation has 2,000,000 shares of common stock authorized. The company has issued 1,000,000 common shares of which 200,000 shares are treasury stock. The company has earnings of $2.00 per share. The XYZ Corporation has repurchased:

200,000 shares XYZ corporation has repurchased 200,000 shares. This is known as treasury stock. Treasury stock is previously outstanding stock that has been repurchased by a corporation.

ABC Corporation's charter authorized the issuance of up to 1,000,000 shares of stock. The company has issued 100,000 shares, but has 5,000 shares of treasury stock. How many shares of ABC's stock are outstanding?

95,000 The number of shares outstanding is equal to the number of shares issued, minus any treasury stock (stock the company has bought back in the open market). 100,000 shares issued minus 5,000 shares of treasury stock equals 95,000 shares outstanding.

A customer owns 50 shares of ABC Corporation. ABC Corporation is engaging in a rights offering. Each existing share receives one right. The terms of the offering are that 10 rights plus $35 is required to buy one new share of stock. If the customer wanted to subscribe to the rights offering, how many additional rights would she need to buy 100 new shares of stock?

950 The terms of the rights offering are that 10 rights are required to subscribe to one new share of stock. If an investor wanted to subscribe to 100 shares of stock, the investor would need 1,000 rights. (10 rights x 100 shares = 1,000 rights.) The investor owns 50 shares of stock and will receive 50 rights from the corporation (one right for each share owned). If the customer wanted to subscribe to 100 shares through the rights offering, the investor would need to purchase an additional 950 rights.

A customer has an account with a discount broker-dealer that specializes in online trading. If the customer is being charged a commission, the firm is MOST likely acting in which of the following capacities?

Agent

An investor owns a $100 convertible preferred stock that is convertible into 2 shares of common stock. The common is selling at $52 and the preferred is selling at $104. The preferred stock is called at 105. What should the investor do?

Allow the preferred to be called The value of the preferred ($104) equals the value of converting to common (2 shares at $52 per share). The investor will receive the greatest amount ($105) by allowing the preferred to be called.

When trading equity securities, the term dark pool is BEST defined as trading:

Between investors, allowing them to buy and sell securities anonymously without quotes being displayed

Math Industries is seeking to maximize shareholder value by spinning off its Algebra Analytics Division. If this action is undertaken, Math Industries' current shareholders would own stock in:

Both companies with no immediate tax consequences

An individual is interested in an investment that offers annual income, has the potential of appreciating in value if interest rates decline and, in the event that the issuer fails to make a payment, having the missing amount added to future distributions. For this investor, which of the following securities is the most suitable?

Cumulative preferred stock Individuals generally purchase preferred stock for income. As with any security that pays a fixed rate, there is the potential for appreciation if interest rates decline. There are several types of preferred stock. Cumulative preferred stock will add all unpaid dividends to a future payment if a cash dividend is to be paid to common shareholders. Participating preferred stock allows the owners to share in the extraordinary earnings of a company. Essentially, participating preferred has a stated dividend, but these shareholders may receive more than that amount based on the profits of the issuing company. Convertible preferred stock allows the owner to convert the stock into a fixed number of common shares. Callable preferred stock allows the issuer to retire (call) the stock in at a predetermined price.

A method of voting that gives smaller, less substantial stockholders a greater degree of voting power over the larger, more substantial stockholders is:

Cumulative voting

Which TWO of the following activities are normally functions of the investment banking department of a broker-dealer? I. Working with issuers to raise capital II. Selling securities to institutional investors III. Assisting companies with mergers and acquisitions IV. Making a secondary market for new issues

I and III

Which TWO of the following activities would require special disclosure documents? I. Penny stock trading II. Trading in high-yield bonds III. Day trading IV. Online trading

I and III

All of the following statements are TRUE regarding ADRs, EXCEPT:

The increased trading volume and enhanced liquidity in the U.S. markets lead to prices that are virtually identical to those of the underlying stock in the issuer's host country

The Pink Marketplace displays:

The market makers for stocks that are not listed on either the NYSE or Nasdaq

Which of the following statements is TRUE concerning electronic communication networks (ECNs)?

They can be used by investors who want to trade anonymously.

Which of the following transactions are NOT exempt from the penny stock disclosure rules?

Transactions with established customers

An investor would have the right to buy the stock of a corporation for the longest period of time by purchasing a:

Warrant