SIE Ch. 2

Convertible preferred stock is issued with a par value of

$100

Preferred Stock qualities

Fixed dividends Interest rate sensitive Income oriented Senior security (Higher liquidation and dividend priority over common) No preemptive rights Par value is usually $100

Seller/Writer/Short an option

Sold the option contract and has an obligation to buy or sell the underlying security.

Premium

The amount an investor will pay for an option; this number is based on 100 shares of the underlying security. An option with a premium of 2 would cost a buyer $200.

cost basis

The cost basis is important when considering the impact of dividends and stock splits. The customer's original cost basis will be adjusted based on reinvested distributions.

Record Date

The date on which an investor must own the stock to receive the dividend. This date is set by the board of directors. Only "shareholders of record" will receive a dividend.

Declaration Date

The date on which the board of directors announces the company will pay a dividend to shareholders.

Payable Date

The date on which the company pays the dividend to the shareholders of record. This date is set by the board of directors and is usually a week or more after the record date, so the company has sufficient time to ensure all shareholders entitled to receive the payment are accurately paid.

Expiration Date

The last date the option can be exercised. Most options have a 9-month life. Once this date passes, the option is worthless.

Breakeven Point

The point that the option buyer will not make any money or lose any money if the contract is exercised—this means that the market price is above or below the strike price by the exact amount of the premium paid.

Strike Price

The price the option will be exercised at. It is set at the time the option is written.

parity

This is the price at which the current market price of the preferred and the value of the common stock at conversion are equal .

cumulative voting

Under cumulative voting, investors are awarded a maximum number of votes based on the number of shares they own multiplied by the number of open seats.

Common Stock qualities

Voting rights Must be issued before preferred Growth and appreciation Junior security (Lower liquidation and dividend priority than preferred) May be entitled to preemptive rights Par value is irrelevant

Dividend Yield formula

Dividend Yield = Annual Dividend ÷ Current Market Price

parity equation

Preferred Market Price ÷ Conversion Ratio = Parity

Call Contract

Provides the holder the right to BUY a specific stock, and the writer an obligation to SELL the specific stock, at the agreed (strike) price.

Put Contract

Provides the holder the right to SELL a specific stock, and the writer of the contract an obligation to BUY a specific stock, at the agreed (strike) price.

Bullish

Put writer call buyer

Short + Put

Seller/Writer Received Premium Obligation to Buy Stock Bullish (Market Rises) Max Gain = PREMIUM RECEIVED Max Loss = STRIKE PRICE less PREMIUM RECEIVED BE = STRIKE $ - PREMIUM

Short + Call

Seller/Writer Received Premium Obligation to Sell Stock Bearish (Market Falls) Max Gain = PREMIUM RECEIVED Max Loss = UNLIMITED BE = STRIKE $ + PREMIUM

Stock Quotes

1 point equals $1

Place the stock dividend dates in order of occurrence

1) Declaration Date 2) Ex-Dividend Date 3) Record Date 4) Payable Date

What is a round stock?

100 shares

Issued Shares minus Treasury Shares=

= Outstanding Shares

Speculator

A person who predicts which direction the market will take to anticipate profitable movement in the market and is said to be speculating.

par value

AKA nominal face value... is an arbitrary amount (such as $0.01 a share or $0.10 a share) and is used for accounting purposes on the company's financial statements. There is no relationship between the par value and the market price at which the shares are traded.

Unrealized gains

AKA paper gains are the gains shown on the growth of an investment that is still held, but not sold

Index Options

An option contract based on an index vs. an individual stock and is considered less risky than an equity option.

Equity Options

An option contract based on an individual stock.

In-the-Money

An option is "in-the-money" when it has intrinsic value. In-the-money has to do with the strike price as it relates to the current market value of the underlying stock.

Uncovered (Naked)

An option writer that does not own the underlying security of the option is said to be uncovered, or naked.

Covered

An option writer that owns the same amount or more of the underlying security is said to be covered.

Holder/Buyer/Long an option

Bought the option contract and has the right to buy or sell the underlying security.

Long + Call

Buyer/Holder Paid Premium Right to Buy Stock Bullish (Market Rises) Max Gain = UNLIMITED Max Loss = PREMIUM PAID BE* = STRIKE $ + PREMIUM

Long + Put

Buyer/Holder Paid Premium Right to Sell Stock Bearish (Market Falls) Max Gain = STRIKE PRICE less PREMIUM PAID Max Loss = PREMIUM PAID BE = STRIKE $ - PREMIUM

Which type of security must all corporations issue?

Common stock

stock split

DOES require shareholder approval. The reason a corporation will split its stock is to make the stock more marketable, or make the price more attractive for investors trading the stock in the secondary market. The company will issue more shares based on a ratio, such as 2-for-1. This will adjust the stock's par and market value, but will not affect the total value of the stockholder's investment.

Ex-Dividend Date

On this day, the security begins to trade without the value of the dividend in the stock price. The ex-dividend date is 1 business day before the record date (R-1). This date is set by FINRA.

issued shares

Once authorized shares have been sold to investors

reasons for buyback

One reason is to reduce the number of shares that are held publicly and increase the earnings on the ones remaining. Another reason is to stop a potential merger by acquiring more than a majority of the outstanding shares.

American Options

Option contracts that can be exercised any time before expiration during the life of the contract. All equity options trade as American options.

European Options

Option contracts that can only be exercised on the expiration or maturity date. Both American and European options can TRADE at any time.

stock dividend

Paying stock dividends does not require shareholder approval and is not considered a taxable event. The investor will simply adjust the cost basis per share. This means that the total value of the investor's holdings will not change, rather the number of shares and the cost basis will. When the investor receives the stock dividend, it is not a taxable event. Instead, it becomes taxable as a capital event (gain or loss) upon sale, based on the adjusted cost basis.

Realized gains

When an investor sells an investment for more than its purchase price or their cost basis

buyback

When corporations want to invest in themselves

statutory voting

When voting for members of the board, the number of statutory votes is the maximum that may be voted for each available seat on the board

tender offer

With a tender offer, the corporation offers to purchase some of the shares currently held by investors at a premium. The investor has the option of tendering all, some, or none of their shares

option

a legal financial contract between two parties, the option writer, or seller, and the option holder, or buyer. exist on stock, bond yields, bond prices, stock market indices, and foreign currency.

Preemptive rights

allow existing common stockholders to maintain their proportionate ownership in the company. The existing stockholder can use the right in order to acquire new shares of common stock. This allows them to retain their percentage of ownership in the company and not dilute any earning potential. The exercise price, or subscription price, is set below the current market price for the common stock when issued. If a stockholder with preemptive rights allows the rights to expire, their ownership in the company will be diluted.

convertible preferred stock

allows the owner to exchange preferred shares for a fixed number of common shares at a specified price, called the conversion price

SEC Rule 145

allows the reclassification of shares because of M&A This means that the newly created shares of the M&A can simply reclassify and do not need to go through the time and expense associated with registration.

Bearish investors

anticipate that stock prices will fall

Bullish investors

anticipate that stock prices will go up

Put buyers

are bearish, since their options become more valuable as the stock goes down.

Speculators

are betting on the direction of a particular stock or market as a whole. Bullish speculators will buy calls or sell puts. Bearish speculators will sell calls or buy puts

Cash dividends

are payable in terms of a dollar amount for each share owned. They are typically declared and paid quarterly, but are stated as an annual rate. A $.10 quarterly dividend may be stated as a $.40 annual dividend. Cash dividends are taxable at preferential rates in the year received. Customers also have the option of reinvesting their dividends. In either case, a cash dividend is taxed in the year it is received. Reinvested dividends are added to the customer's cost basis for tax purposes.

property dividends

are usually paid in the form of the company's products. For example, Starbucks might give each of their shareholders coupons for free coffee. Shareholders must report the value of that property as ordinary income in the year they receive it.

bearish

call writer put buyer

Common stock dividends are only paid if :

declared by the board of directors

conversion ratio

equates to how many shares of common stock the investor will receive when converting one share of preferred.

call option

gives the holder the right, but not the obligation, to buy 100 shares of stock at a specified price, called the strike price, up until the expiration date of the option contract. If the holder of a call contract exercises the right to buy stock, then the call writer must sell the stock to the call holder at the strike price.

options contract

gives the option holder the right to buy or sell 100 shares of a specific stock at a predetermined price, the strike price, for a specified time period

put option

gives the option holder the right, but not the obligation, to sell 100 shares of stock at the strike price, up until the expiration date of the option contract. If a put holder exercises the right to sell stock, then the put writer must buy the stock from the put holder at the strike price.

Options Clearing Corporation or OCC

handles trading of listed equity options

option contract buyer qualities

has right to buy or sell holder pays premium long

proxy

how shareholders can vote by mail

Hedging

in the options market involves protecting an appreciated stock position against large losses. When someone is long a stock position, they expect the stock to rise in value. A put option could be purchased to protect that investor in case they are wrong and the stock price drops. This would allow them to sell the stock at the put strike price vs. the market price. With a short stock position, the investor wants the price of the stock to decrease. A long call could be purchased to protect them if the stock price rises. The call could be exercised and the investor would purchase at the strike price vs. the current market price.

dividend

is a distribution of a portion of a company's earnings. Shareholders are entitled to their share of the profits in the form of dividends when and if they are declared by the board of directors. Shareholders do not vote on the payout of dividends. Some corporations do not pay dividends but choose, instead, to reinvest earnings back into the company to fund future growth.

Dividend Yield

is a measure of the return on investment for a stock. When discussing a stock's dividend yield, investors compare the annual dividends to the current market price of the stock.

major advantage of incorporating a business is:

the legal protection afforded to its shareholders shareholders have a limited liability and can only lose their original investment in the company Any lawsuits will be directed against the company, instead of to its individual shareholders

preferred stock

is an equity security that offers ownership interest to investors. can only be issued by a corporation after common stock has been distributed. receives preferential treatment over common stock in dividend payments and bankruptcy proceedings. dividends are not guaranteed for any class of stock, including preferred. In the event the corporation goes bankrupt, the preferred stock has a higher claim to assets than the common stock. This means that preferred stock will receive dividends and principal back before a common stock receives a payment. "non-voting" stock and have no control over electing board members These investors are more interested in the income stream that shares are expected to provide through quarterly dividends. Preferred stock usually offers investors a higher dividend rate than is paid on the common stock.

Common stock

is issued by corporations and is the most "junior" security. Upon a corporation's bankruptcy, common shareholders are the last to have any claims on residual assets and earnings of the corporation. This type of stock carries the greatest risk of loss when compared to any other security issued by the corporation, but it also provides investors with the highest possible capital appreciation.

Market value

is the most meaningful measurement of value for the average investor. It is the price investors will pay for the stock in the secondary market. Market value is determined by supply and demand through the trading of the shares on a stock exchange or in the over-the-counter market.

Book value

is the theoretical liquidation value of the business. This is what the stock would be worth if the assets are sold, the liabilities are paid, and any other obligations of the corporation are settled.

Callable Preferred Stock

issuer, at its discretion, has the right to buy back the shares at a specified price, after a certain time, and cancel the stock. If the preferred stock is called, the investor is obligated to sell the stock back at the specified price (at least par value). Usually, the company will call the issue when interest rates are low, and they can reissue stocks with a lower dividend.

acquisitions

one company completely takes over another company. In this case, the acquired company's shares disappear and are replaced by the buying company's shares in proportion to ownership

American Depositary Receipts (ADRs)

provide a fast and efficient way for investors to purchase shares of foreign corporations in the U.S. securities markets with U.S. dollars. ADRs are created when a U.S. financial institution purchases large blocks of shares of a foreign corporation in a foreign country and deposits the securities in an overseas bank. The bank registers ADRs as a security with the SEC, then issues a receipt (ADR) for the stock, which will trade as a separate security in the U.S. market. Each receipt may represent ownership of one or more of the underlying foreign shares. Dividends paid by the foreign corporation are passed through the bank and paid to U.S. investors in U.S. dollars. Taxes are withheld before being paid to the investors. The depository bank may retain the voting and preemptive rights on the shares and investors never receive preemptive rights on the underlying foreign stock.

option writer

sells the contract to the option holder for a premium and is obligated to fulfill the terms of the contract (either buying or selling the specific stock) as exercised by the holder

negotiable security

shareholders are generally free to give, transfer, assign, or sell shares at any time without restrictions

Owners of a corporation

shareholders or stockholders

Stock rights

simply called rights, allow an investor that holds them the ability to purchase stock at a discounted price. They are very short term and typically expire in 1 or 2 months.

Calls are in the money if

the market price is higher than the exercise (strike) price. An investor can exercise their call and purchase the underlying stock at a lower price than the current market value. Intrinsic value or "in-the- money" is always looked at from the option holder's position.

Puts are in-the-money when

the market price is less than the strike price. Owning a put is a bearish position and the holder of a put wants the market price of the stock to drop. For the put to be "in-the-money", the market price of the stock would need to drop below the strike price of the option. If this happens, the investor that is long the put can exercise the option and sell their stock at a higher price than the current market value.

A CALL is in-the-money when

the market price of the stock is ABOVE the strike price.

A PUT is out-of-the-money when

the market price of the stock is ABOVE the strike price.

A CALL is out-of-the-money when

the market price of the stock is BELOW the strike price.

A PUT is in-the-money when

the market price of the stock is BELOW the strike price.

currency risk

they represent ownership of a security that is not dollar denominated. The value of the ADR will track with that of its underlying shares. Currency (exchange-rate) risk represents the inverse relationship between the U.S. dollar and foreign currency.

exchange offers

to reduce the number of common stock shares in the hands of the investing public. With an exchange offer, which is considered a type of tender offer, the corporation offers shareholders the option of trading in their common stock shares for another security, such as a bond or a preferred stock.

mergers

two or more companies combine into one Each of their shareholders are now shareholders of the merged company Often, stock shares of the old companies are replaced by the new combined company's shares

Call buyers

want stocks to go up, because they can buy the stock at the guaranteed "locked in" strike price, no matter the market value.

reverse stock split

when share prices are perceived to be too low

option contract seller qualities

writer receives premium payment has obligation to buy or sell short

ARD Key Points:

◾Are dollar denominated ◾Pay dividends in U.S. dollars ◾Subject to foreign taxation on dividends ◾ Subject to currency risk ◾Lack voting and preemptive rights

Dividend can be paid in the form of:

◾Cash ◾Stock ◾Property

Treasury stock:

◾Has no voting rights ◾Does not receive dividends ◾Is purchased by the issuer to increase earnings per share Treasury shares can be retired permanently, or can be used to fund employee stock plans or be paid to stockholders in the form of a dividend

Shareholder rights

◾Mergers and acquisitions ◾A change in the authorized number of shares ◾Stock splits ◾Elect board members *Stockholders do not vote for dividends.*

Preferred stock

◾Represents equity (ownership) ◾Fixed dividend ◾Interest rate sensitive ◾No voting rights ◾Preference over common stock in dividends and bankruptcy

interest rates and preferred stock price correlation

◾When current interest rates rise, preferred stock prices decrease ◾When current interest rates fall, preferred stock prices increase