Unit 3 Equity Securities Questions
Which of the following is not a right conferred upon ownership of common stock? A) Limited liability B) Voting in person or by proxy C) Transferability of shares D) Dividends, if declared by the board of directors
A) Limited liability Although ownership of common stock means the holder's maximum loss is limited to the original investment, it is not a stockholder right. The doctrine of limited liability is a legal construct and shields stockholders from being responsible for debts of the company. Being able to vote the shares; being able to sell them without needing the issuer's permission; and dividends, if declared, are considered rights of owning stock.
For tax-reporting purposes, qualified dividends are considered to be what type of income? A) Portfolio B) Passive C) Earned D) Phantom
A) Portfolio Portfolio income includes dividends (qualified or not), interest, and net capital gains derived from the sale of securities.
Which of the following equity securities has the longest expiration date? A) Warrants B) Preferred stock C) Common stock D) Preemptive rights
A) Warrants Warrants commonly have expiration dates that are one, five, or even more years in the future. Preemptive rights generally expire in a maximum of 45 days, and common and preferred stock do not have expiration dates.
A type of alternative trading system that trades listed stocks and is required to register with the SEC as a broker-dealer is A) an ECN. B) an ETN. C) the fourth market. D) a dark pool.
A) an ECN. Electronic communication networks (ECNs) are a type of alternative trading system (ATS) that trade listed stocks and other exchange-traded products. Unlike dark pools, another type of ATS, ECNs display order in the consolidated quote stream. As ATSs, ECNs are required to register with the SEC as broker-dealers and are also members of FINRA. Trading in the fourth market (institution to institution) is done largely through ECNs.
Prior to effecting an initial penny stock transaction for a new customer, the registered representative must do all of the following except A) determine if the client has been receiving monthly statements. B) obtain a signed suitability statement from the customer. C) determine suitability based on financial condition, investment experience, and investment objectives. D) obtain a signed risk disclosure document from the customer.
A) determine if the client has been receiving monthly statements. The question tells us this is the first trade in penny stocks for a new customer. The monthly statements haven't started yet. The penny stock rules require registered representatives to provide disclosure information to all penny stock buyers. In addition, they must determine suitability based on financial information, investor experience, and objectives supplied by the buyer. As additional protection, the customer must sign the suitability statement.
If a client asked you about an equity security with a cumulative feature, the question would most likely be dealing with A) preferred stock. B) outstanding stock. C) preemptive rights. D) common stock.
A) preferred stock. It is preferred stock that can offer the cumulative feature. Cumulative refers to the fact that dividends in arrears (past dividends that haven't been paid) accumulate and must be paid along with the current dividend before any dividends can be paid on the issuer's common stock. The term never applies to common stock and preemptive rights. Aren't these shares of preferred stock outstanding? Yes—if they weren't, there wouldn't be any dividends to accumulate. Why isn't that the answer? Because common stock is also outstanding; that choice doesn't directly answer the question. Sometimes there is a second choice that is a true statement, but it is not the best answer to the question. In this case, the question is dealing only with the cumulative feature.
KAPCO Manufacturing Corporation declares a 5-for-1 stock split on its outstanding shares of $20 par value common stock. This split will cause A) the par value of the shares to change to $4 per share. B) the price of the shares to change to $4 per share. C) the dividend per share on KAPCO's preferred stock to be reduced. D) a change to KAPCO's net worth.
A) the par value of the shares to change to $4 per share. Whenever there is a stock split (forward, such as this, or reverse), the par value is adjusted for the split. With a $20 par and a 5-for-1 split, the par value now becomes $4 per share. The stock's market value will drop by approximately 20% (⅕) of the pre-split price. The question only tells us the par value, not the market value (and those two values are unrelated). A split to the common stock has no effect on the preferred stock. The net worth remains the same because no money is involved.
XYZ Widgets is a publicly traded corporation. Upon the death of one of the founders of the company, a donation of 100,000 shares of XYZ stock is made by the executor of the deceased's estate. This would now be considered A) treasury stock. B) retired stock. C) unissued stock. D) outstanding stock.
A) treasury stock. Treasury stock is issued and outstanding stock of the corporation that has been reacquired by the company. In some cases, such as this question, the stock is donated back to the company, but in most cases, it has been purchased by the company in the open market. Regardless of how stock is acquired, it is no longer outstanding, and it is held in the company's treasury. Once stock has been issued, it is always issued, even when it is no longer outstanding. How do we know the stock was donated back to the company and not to a charity? The key is the word now in the final sentence. Now means that something has changed. If the shares were donated to a charity, they would still be outstanding—nothing has changed. It is only because they were donated back to the issuer that there has be a status change.
A corporation is having a rights offering. The terms of the offering require six rights plus $60 to purchase one share. With the stock's current market price at $74 per share, the theoretical value of one right before the ex-rights date is A) $0.20. B) $0.23. C) $2.00. D) $2.33.
C) $2.00. Because the question is asking about the value before ex-rights, it means we use the cum-rights (with rights) formula; that is, the market price minus the subscription price divided by the number of rights it takes to buy one share plus one. Plugging in the numbers gives us ($74 - $60) ÷ (6 + 1) = $14 ÷ 7 = $2.00.
Which of the following statements regarding ADRs is not true? A) ADRs make it easy to own a foreign security. B) Dividends are received in U.S. dollars. C) Holders generally have voting rights. D) Key risks to identify include currency and political risks.
C) Holders generally have voting rights. ADRs, with few exceptions, do not have voting rights. The sponsor of the ADR (the bank) holds the foreign securities and issues a receipt for them. That receipt is the ADR, and it is a U.S. security traded in the U.S. markets in U.S. dollars. Of importance to the holder is that everything is in English and dividends, if any, are received in U.S. currency. Therefore, it is correct to state that the holder of an ADR does not hold the shares of the underlying foreign security but instead holds a receipt for that security. There is both currency and political risk associated with ADRs.
Common risk factors found when investing in penny stocks would include all of the following except A) limited transparency. B) illiquidity. C) unfavorable tax treatment. D) high volatility.
C) unfavorable tax treatment. The tax treatment on gains or losses in penny stock investing are no different from any other stock. But penny stocks have these other risks. Because these are not traded on the exchanges or Nasdaq, it is not always easy to find a buyer or seller at your price. Many of these companies are not bound by the same financial reporting requirements as listed companies, making it difficult to really determine where the money is going. These low-priced stocks tend to fluctuate much more, with daily price swings of 25% or more not being unusual.
