SIE Chapter 3

A corporation has a 9% cumulative preferred stock issue outstanding. The company paid a $7 dividend in 2012 and $8 in 2013. If the company wants to pay a common stock dividend in 2014, the cumulative preferred stockholders must first receive a dividend of:

$12 The cumulative preferred stockholder should receive a yearly dividend of $9. Since it is a cumulative issue, any dividend that is not paid must be made up prior to a common dividend being paid. If a common dividend is to be paid in 2014, the cumulative preferred stockholders must first receive $12 ($2 for 2012 plus $1 for 2013 plus $9 for 2014).

XYZ corporation has 7,000,000 shares of common stock ($1 par value) authorized, of which 5,000,000 shares have been issued. There are 500,000 shares of treasury stock. The current market price of XYZ is 20. The market capitalization of XYZ common stock is:

$90,000,000 A company's market capitalization is found by multiplying the market value by the outstanding shares. $20 market value x 4,500,000 shares outstanding = $90,000,000.

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 French company would like to have its stock traded in the U.S. securities markets. This would most likely be accomplished through the issuance of:

American Depositary Receipts American Depositary Receipts (ADRs) facilitate U.S. investment in foreign securities. The foreign securities are deposited in a branch of a U.S. bank located in that country. A receipt for those securities is then issued and traded in the U.S. as if it were the foreign security itself. A Global Depository Receipt (GDR) is incorrect because it trades in foreign markets, not in the U.S.

A company based in Europe with offices located in New Jersey would like to have its stock traded on the NYSE. This would most likely be accomplished through the issuance of:

American Depositary Receipts (ADRs) American Depositary Receipts (ADRs) facilitate U.S. investment in the stock of foreign corporations. When the foreign securities are deposited in a U.S. bank based in that country, a receipt for those securities is issued and traded in the U.S. as if it were the foreign security itself.

Foreign stocks trade in U.S. markets as:

American Depositary Receipts (ADRs) American Depositary Receipts are used to facilitate the trading of foreign stocks in the United States. Unregistered securities are securities sold to investors that do not require registration with the SEC (for example, a private securities offering). An exchange-traded fund (ETF) is a type of investment company that represents a basket of securities and is traded on an exchange. The basket of securities usually represents an index such as the Nasdaq 100 or the S&P 500. A closed-end mutual fund is also a type of investment company that issues a fixed number of shares.

If a corporation believes that its stock is undervalued, which of the following actions will cause the share price to rise?

Buying back some of the shares One reason that a company will buy back its own shares is that it believes that the stock is undervalued. Once the buy-back is done, there are fewer shares (i.e. lower supply) and the price of the shares will typically rise. Issuing new shares will increase the number of shares outstanding, which could decrease the price of the shares. Creating new rights and warrants could also increase the shares outstanding, which is likely to cause the stock's price to decrease.

During a period of stable interest rates, which type of preferred stock tends to be the most volatile?

Convertible Convertible preferred stock may be converted into a fixed number of common shares of the same issuer. For that reason, if the common stock into which the preferred stock may be converted has appreciated above the parity price, the value of the convertible preferred will also rise. During a period of stable interest rates, the other types of preferred stock tend to remain stable.

Which shares of preferred stock may increase the most if the value of the company's common stock appreciates?

Convertible preferred stock Convertible preferred stock can be exchanged for the common stock of the issuer. For that reason, if the common stock's value increases, the market value of the convertible preferred stock will also increase.

Last year, a company failed to pay the full dividend to its preferred shareholders, but now wants to pay a cash dividend on its common shares. Which preferred stock must be paid all of the dividends in arrears before the dividend can be paid on its common shares?

Cumulative preferred If a corporation has failed to pay dividends in full on its preferred shares, cumulative preferred stock must be paid any dividends in arrears (missing) before common shares are paid cash dividends. Participating preferred allows the holder to receive an additional amount (along with common shares) if company profits reach a certain level. Convertible preferred can be converted into common stock of the issuer, and callable preferred can be called back from the holder by the issuer.

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 A method of voting that gives larger, more substantial stockholders a greater degree of voting power over smaller, less substantial stockholders is statutory voting. Under statutory voting, each stockholder has one vote per share, per election. For example, if a corporation is electing three directors, and a shareholder owns 100 shares, the shareholder could cast 100 votes in each election. Cumulative voting permits shareholders to concentrate their votes for one favored candidate. For example, if a corporation is electing three directors and a shareholder owns 100 shares, that shareholder could cast 300 votes for one director, potentially having a larger influence on that one election.

A company in which your client owns stock is about to make a rights offering. The client informs you that he does not plan on subscribing to the offer. You would tell the client that his proportionate ownership interest in the company would:

Decrease If an individual does not subscribe to additional stock in a rights offering, his proportionate ownership interest in the company will decrease.

Preferred shares:

Don't have the right to vote Preferred shares receive dividends before the common shares. In addition, preferred shares will be paid before common shares if the company declares bankruptcy (i.e., if the firm is liquidated). However, the bondholders are paid before the preferred shares in bankruptcy. Typically, only common shareholders of a company receive the right to vote in corporate elections.

When warrants are issued, the exercise price is:

Higher than the current market price of the stock Warrants are typically issued with a strike price that's higher than the current market price of the stock (i.e., at a premium).

Preferred dividends:

Must be satisfied before common dividends Preferred shares receive dividends before the common stock dividends can be paid. However, a company doesn't guarantee preferred dividends will be paid each year.

The certificate which gives a person other than the stockholder the right to vote is referred to as a:

Proxy The certificate which gives a person other than the stockholder the right to vote is referred to as a proxy. Although stockholders have the right to attend shareholder meetings in person, most do not. Instead, the stockholders sign a proxy which directs a designated person on how to vote their shares.

The security with the longest expiration date would normally be a:

Warrant A warrant generally has an expiration date longer than a put, call, or right. There are some warrants which never expire.

Common and preferred stock are similar in that:

The dividends for both must be declared by the board of directors Dividends for both common and preferred stock must be declared by the board of directors. While preferred stock normally has a fixed dividend, neither common nor preferred stockholders are guaranteed a dividend.

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 American Depositary Receipts (ADRs) are priced in dollars and are sensitive to the value of the stock and the fluctuations of the currency in the underlying issuer's host country. ADRs may be listed on an exchange and may be sponsored by the company (issuer). The trading volume of ADRs varies considerably among issues. Securities that are not heavily traded may have significant disparities between the price of the ADR and the underlying stock.

A Japanese manufacturer of handheld gaming devices does not want to pay for the costs associated with having its shares traded in the U.S. Which of the following statements is TRUE?

The shares may be traded in the U.S. as an unsponsored ADR An American Depositary Receipt may be sponsored by the company whose common stock underlies the ADR, or it may be unsponsored. In a sponsored ADR, the company pays a depositary bank to issue shares in the U.S. Many of the largest ADRs are sponsored. This allows the company to raise capital in the U.S. and list the ADR on the NYSE, or Nasdaq. In an unsponsored ADR, the company does not pay for the cost associated with trading in the U.S. A depositary bank issues the ADR. In an unsponsored ADR, the issue will trade in the OTC market, and will usually be quoted on the OTC Pink Market, Inc. (the electronic Pink Sheets).

Preemptive rights provide which of the following benefits to their holders?

Their proportionate ownership will not be diluted if additional shares are issued. If a company decides to issue additional shares, preemptive rights allow existing shareholders to maintain their proportionate interest in the company by exercising their rights.

Which of the following statements is NOT TRUE about preemptive rights?

They receive the same dividends as those paid to shareholders. Preemptive rights are short-term securities which allow the holder to purchase stock at a reduced price, they can trade in the secondary market, and shareholders receive one for each share they own. However, rights don't receive dividends.

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

Warrant A warrant is the right to purchase a fixed number of shares, at some future time, at a fixed price. This is also true of rights and call options but warrants may be exercised over a longer period of time. A put option is the right to sell securities at a fixed price within a fixed period of time.

Which of the following statements is TRUE regarding warrants?

Warrants can be perpetual Warrants can be perpetual in their duration and are issued by the corporation that also issues the common stock. Warrants give the holder the ability to convert the warrant into the common stock of the same corporation at a specified price and at the holder's option.

Which of the following represents the correct ranking of securities from longest to shortest life?

Warrants, options, rights Rights usually last less than 60 days. Options usually last for nine months or less, although some can exist for three years. Warrants usually have a life span of several years and they can even be perpetual.

A corporation's shareholders must vote for:

stock splits The board of directors has control over dividends but must have shareholder approval for a stock split.