Unit 1 - Series 65

The board of directors of DDC omitted dividends in 2020 on their $100 par 6% noncumulative preferred stock. In 2021, a $2 preferred dividend was paid. For DDC, 2022 has been a good year, and the board wishes to pay a common dividend. How much must be paid per share on the preferred for 2022 in order to pay a common dividend? A) $6 B) $16 C) $12 D) $8

A) $6 Explanation Because this preferred stock is noncumulative, any missed dividends need not be paid before common dividends can be declared. If this were a cumulative issue, any dividends not fully paid would go into arrears and accumulate until paid to the preferred cumulative stockholder. During this time, common dividends could not be declared or paid until the cumulative holders were paid in full. A 6% dividend on a $100 par means a $6 dividend each year per share.

Which of the following has the least exposure to inflation risk? A) Common stock B) Preferred stock C) Cash D) Fixed annuity

A) Common stock Explanation The returns on common stock have historically outperformed inflation, making them less vulnerable to loss of purchasing power among the choices presented. Cash is a store of present purchasing power that inflation will erode. Fixed annuities have more exposure to inflation than common stock because their payments are fixed in nominal dollars. Preferred stock has the same exposure to inflation risk as do all fixed-income instruments.

Under Rule 144, which of the following sales are subject to volume limitations? I. Control person selling registered stock held for one year II. Control person selling restricted stock held for two year III. Nonaffiliate selling registered stock held for one year IV. Nonaffiliate selling restricted stock held for two year

A) I and II Explanation Control persons are always subject to volume limitations.

Investing in emerging market stocks is least likely to expose your client to which of the following risks? A) Interest rate B) Political C) Liquidity D) Currency

A) Interest rate Explanation Interest rate risk applies primarily to fixed income securities. Stock, unless it specifies preferred stock, are not normally considered to have interest rate risk. However, any foreign investment incurs currency risk and, when dealing with emerging markets, there is a higher degree of liquidity and political risk than with developed economies.

Which of the following sell transactions is not subject to the holding period restriction specified in SEC Rule 144? A) Stock acquired on the NYSE by a corporate affiliate B) Stock acquired by a corporate affiliate in a private placement C) Unregistered stock acquired by a nonaffiliate under an investment letter D) Unregistered stock acquired by a corporate affiliate in a stock option program

A) Stock acquired on the NYSE by a corporate affiliate Explanation The holding period rule applies only to unregistered stock, which may or may not be control stock. Unregistered stock results from either private placements or the exercise of a corporate stock option. Because this question asked which securities were not subject to the Rule 144 holding period, only stock acquired on the NYSE by a corporate affiliate is the correct answer. However, the affiliated person is subject to volume restrictions.

An investor in an equity security A) acquires an ownership interest in the company. B) has a say in the day-to-day operations of the business. C) is assured of a minimum rate of return. D) becomes a creditor of the company.

A) acquires an ownership interest in the company. Explanation Equity means ownership, and this is a characteristic shared by both common and preferred stock. Holders of debt securities are creditors, and there are no guarantees when it comes to returns on equity securities. Only common stockholders have voting rights, but even then, those rights don't deal with daily operations because the vote is generally used at the annual meeting to vote for members of the board of directors.

The residual right of common shareholders refers to their right to A) claim company assets in bankruptcy after wages, taxes, creditors, and preferred shareholders have been paid. B) examine the corporation's annual reports and other reports, and take legal action if irregularities are found. C) vote in elections for the board of directors and in other important business decisions, such as changes to the charter. D) receive all announced dividends in accordance with the number of shares held.

A) claim company assets in bankruptcy after wages, taxes, creditors, and preferred shareholders have been paid. Explanation The residual right of common shareholders refers to their position in the event of bankruptcy.

Ownership in a corporation is evidenced by holding shares of the company's A) common or preferred stock. B) warrants. C) bonds with a first mortgage on the property. D) common stock only.

A) common or preferred stock. Explanation If you have equity in a corporation, it means you have an ownership interest. Equity securities (common and preferred stock) represent ownership in a corporation. A mortgage bond is a debt security, and a warrant gives the holder the right to acquire equity but, in itself, is not equity.

Investing in an emerging market mutual fund subjects the investor to all of the following risks except A) liquidity. B) political instability. C) market volatility. D) currency fluctuations.

A) liquidity Explanation Although direct investment in emerging market securities would have liquidity risk, the benefit of doing so through a mutual fund is that, under federal regulations, the fund must redeem at NAV upon request.

KAPCO common stock is listed on the New York Stock Exchange, Inc. (NYSE). If an executive vice president of the company buys 400 shares of the company's stock on the NYSE, she A) may sell immediately subject to Rule 144 volume limitations. B) may not sell until she leaves the company. C) may sell under Rule 144 only after a six-month holding period. D) may sell immediately without restriction.

A) may sell immediately subject to Rule 144 volume limitations. Explanation If purchased in the open market, such as on the NYSE, the transaction is not a private placement, and the stock does not have a holding period restriction. The officer, however, is an affiliate and is therefore subject to the reporting and volume limitations under Rule 144.

In a portfolio containing common stock, straight preferred stock, convertible preferred stock, and adjustable-rate preferred stock, changes in interest rates would be most likely to affect the market price of the A) straight preferred stock. B) common stock. C) adjustable-rate preferred stock. D) convertible preferred stock.

A) straight preferred stock. Explanation Fixed-income securities, such as straight preferred stock, are the most sensitive to interest rates among the alternatives listed. Convertible preferred stock is influenced more by the common stock because it is convertible into the underlying security. Because the dividend rate on adjustable-rate preferred stock is usually tied to changes in interest rates, the price of this stock remains stable in the face of rising or falling rates.

The board of directors of DDC omitted dividends in 2016 on their $100 par 6% noncumulative preferred stock. In 2017, a $2 preferred dividend was paid. For DDC, 2018 was a good year, and the board wishes to pay a common dividend. How much must be paid per share on the preferred for 2018 in order to pay a common dividend? A) $12 B) $6 C) $8 D) $16

B) $6 Explanation Because this preferred stock is noncumulative, any missed dividends need not be paid before common dividends can be declared. If this were a cumulative issue, any dividends not fully paid would go into arrears and accumulate until paid to the preferred cumulative stockholder. During this time, common dividends could not be declared or paid until the cumulative holders were paid in full. A 6% dividend on a $100 par means a $6 dividend each year per share.

Which of the following statements concerning equity securities is not correct? A) Common stock is an equity security representing an ownership interest in a corporation. B) Equity securities represent a lending interest in a corporation. C) Preferred stock is an equity security with an intermediate claim (between the bondholders and the common stockholders) on a firm's assets and earnings. D) Equity securities provide a residual claim, after payment of all obligations to fixed-income claims, on the income and assets of a corporation.

B) Equity securities represent a lending interest in a corporation. Explanation Equity securities represent an ownership interest in a corporation. Preferred stock, as a senior security, has a claim ahead of common but behind debt securities.

Which of the following statements concerning international direct investing is correct? A) Foreign markets are usually mature and offer no growth advantages. B) Information is not as readily available on foreign investments as on domestic ones. C) The rates of return on foreign securities are generally less than those available from U.S. markets. D) The addition of foreign securities to a portfolio may result in increased portfolio risk due to the different movements of foreign markets and U.S. markets.

B) Information is not as readily available on foreign investments as on domestic ones. Explanation In general, foreign investments don't have the transparency of domestic ones. Rather than directly investing in the foreign security, trading the ADR has the advantage of the full disclosure requirements of the SEC. Investors may earn higher returns in foreign markets, and including foreign securities in an investment portfolio may lower risk through greater diversification. This is because there may be a low correlation with U.S. markets. Although securities markets in most developed economies are mature, that doesn't mean they can't grow, and the markets in emerging economies offer great potential growth commensurate with their greater risk.

Which of the following statements best describes cumulative preferred stock? A) Owners receive an extra dividend, along with common shareholders, in addition to the preferred dividend. B) Owners have a continuing claim to their dividends, and all arrears must be paid before any dividends can be paid on common stock. C) Owners are allowed to vote for directors using the cumulative voting procedures. D) Owners lose any claim to dividends that are not paid in any one year.

B) Owners have a continuing claim to their dividends, and all arrears must be paid before any dividends can be paid on common stock. Explanation Owners of cumulative preferred stock have a continuing claim to their dividends, even when the directors pass a dividend. Their claim accumulates, which means that all past dividends (arrears), as well as current dividends, must be paid before any dividend can be paid on common stock. By contrast, the owners of noncumulative preferred stock lose their claim to dividends that are not paid in any one year.

A company's dividend on its common stock is A) voted on by shareholders. B) determined by its board of directors. C) specified in the company charter. D) mandatory if the company is profitable.

B) determined by its board of directors. Explanation A common stock's dividend payment and amount are determined by the company's board of directors.

All of the following represent ownership in a corporation except A) preferred stock. B) mortgage bonds. C) convertible preferred stock. D) common stock.

B) mortgage bonds. Explanation Ownership in a corporation resides in its equity securities. All stock is equity, while all bonds are debt.

When comparing restricted stock to nonrestricted stock, it is important to note that the restricted stock has a restriction placed upon its A) receipt of dividends. B) resale. C) voting rights. D) priority in liquidation.

B) resale. Explanation When a stock is restricted, the restriction applies solely to a time limit within which the stock cannot be sold. That restriction is found in Rule 144 of the Securities Act of 1933 and applies to unregistered or control stock.

A common stockholder's rights include all of the following except A) preemptive rights. B) the right to determine the par value of the stock. C) electing the board of directors. D) the receipt of dividends if declared by the board of directors.

B) the right to determine the par value of the stock. Explanation Par value is an accounting decision made by the company when the stock is first issued and is not something voted on by shareholders. Common stockholders are the owners of a corporation. This basic form of ownership entitles them to all of the privileges discussed here. It also allows them to transfer their ownership, inspect company records, vote on corporate objectives, and lay claim to any residual assets in the event of a liquidation.

Investments in which of the following offer the best long-term protection against inflation? A) Fixed annuities B) Government bonds C) Common stocks D) Corporate bonds

C) Common stocks Explanation Common stocks have historically offered returns that outpace inflation over the long term. Investments paying a fixed return, such as bonds and fixed annuities, have the greatest inflation risk.

A client is considering the purchase of American depositary receipts (ADRs). The client is looking to further diversify her portfolio. Which of the following is not a feature of this type of investment vehicle? A) Information regarding the foreign company is more easily attainable than if directly purchased. B) ADRs are denominated and pay dividends in U.S. dollars. C) They are not subject to exchange rate, or currency, risk. D) ADRs are both liquid and marketable.

C) They are not subject to exchange rate, or currency, risk. Explanation Even though ADRs are denominated in U.S. dollars, they are subject to exchange rate, or currency, risk. The bank furnishes information about the underlying security in English rather than the foreign language and ADRs are traded like any domestic stock.

The issuer of an ADR is A) the exchange on which the ADR is traded. B) a domestic branch of a foreign bank. C) a U.S. depositary bank. D) a foreign branch of a foreign bank.

C) a U.S. depositary bank. Explanation The stocks of most foreign companies that trade in the U.S. markets are traded as American depositary receipts (ADRs). U.S. depositary banks (domestic branches of U.S. banks) issue these stocks. Each ADR represents one or more shares of foreign stock or a fraction of a share. If you own an ADR, you have the right to obtain the foreign stock it represents, but U.S. investors usually find it more convenient to own the ADR.

An American depositary receipt (ADR) is A) a certificate representing ownership of a U.S. security that is deposited in a foreign bank. B) a document used with interest rate swaps. C) a certificate representing ownership of a foreign security that is on deposit at a U.S. bank. D) a type of derivative used to speculate in foreign currencies.

C) a certificate representing ownership of a foreign security that is on deposit at a U.S. bank. Explanation An American depositary receipt (ADR) is a certificate representing ownership of foreign securities that are on deposit at a U.S. bank. ADRs can be traded on U.S. stock exchanges, are quoted and pay in dividends in U.S. dollars, and receive all the shareholder protections of U.S. securities.

One difference between common stock and preferred stock is that common stockholders A) have a priority claim on earnings. B) own equity in the company. C) have voting rights. D) receive dividends when declared by the board of directors.

C) have voting rights. Explanation It is rare to find a preferred stock with voting rights and even rarer to find a common stock without them. Both receive dividends when, and if, declared by the board of directors, and these dividends are usually paid quarterly. Both are equity securities, and preferred has the prior claim.

An employee is offered a nonqualified stock option with an exercise price of $20 per share. If the option is exercised when the current market value of the stock is $30, the employee A) has a capital gain of $10 per share. B) is taxed on $30 per share as if it were salary. C) is taxed on $10 per share as if it were salary. D) is taxed on $20 per share as if it were salary.

C) is taxed on $10 per share as if it were salary. Explanation In the case of NSOs, the difference between the exercise (or strike) price and the current market value is considered salary to the employee.

The primary defining characteristic of an equity security is A) voting rights. B) the ability to keep pace with inflation. C) it represents ownership in a corporation. D) it pays dividends, usually quarterly.

C) it represents ownership in a corporation. Explanation What does the term equity mean? It means ownership and that is the single most significant fact about an equity security, whether common or preferred stock. Many pay dividends, but that is not at the core of being an equity security. Equity securities include preferred stock, which, with its fixed dividend, does not offer inflation protection and does not have voting rights.

Three years ago, an investor purchased 1,000 shares of stock in the Equity Protective Life Insurance Company (EPLIC). The purchase price was $53 per share. The current market value of EPLIC stock is $79 per share. If the investor is in the 24% federal income tax bracket, it is correct to state that A) the investor owes tax on a $26,000 long-term capital gain. B) the investor's tax liability is $3,900. C) no tax is owed by the investor. D) the investor owes tax on a $26,000 short-term capital gain.

C) no tax is owed by the investor. Explanation Because the investor has not sold the EPLIC stock, the gain is unrealized. It is only when a gain (or loss) is realized that there are tax consequences. Had the stock been sold, it would have been a long-term capital gain, which is taxed at 15% rather than the investor's marginal rate.

An investor holding which of the following equity securities would notexpect to have preemptive rights? A) Common stock B) Common stock acquired in a private placement C) Control stock D) Preferred stock

D) Preferred stock Explanation Preferred stockholders do not have preemptive rights. Preemptive rights allow common stockholders to subscribe to additional issues of shares before they are offered to the public, to maintain their percentage ownership.

A corporation would like to offer their employees an opportunity to participate in the future growth of the company. Among the methods you might suggest are A) subordinated debentures. B) voting trust certificates. C) preemptive rights. D) employee stock options.

D) employee stock options. Explanation One of the most popular ways to give employees the chance to benefit from an increase in the value of the employer's stock is through employee stock options.

One characteristic found in equity securities issued by a corporation is A) cumulative dividends. B) a history of keeping pace with inflation. C) preemptive rights. D) limited liability.

D) limited liability. Explanation Equity securities include common and preferred stock. Both have the benefit of limited liability; the investor can never be held liable for debts of the corporation. Only common stock has preemptive rights and the potential for growth to keep pace with inflation. It is preferred stock that can have the cumulative feature regarding its dividends.

A client has 100 shares of GHI when the stock undergoes a split. After the split, the client has A) a proportionately decreased interest in the company. B) a proportionately increased interest in the company. C) greater exposure. D) no effective change in the value of the position.

D) no effective change in the value of the position. Explanation When a stock splits, the number of shares each stockholder has either increases or decreases (in the case of a reverse split). The customer experiences no effective change in position because the proportionate interest in the company remains the same.

A company that has issued cumulative preferred stock A) forces conversion of the preferred that is trading at a discount to par, thereby eliminating the need to pay past-due dividends. B) pays the preferred dividend before paying the coupons due on its outstanding bonds. C) pays the current dividends on the preferred, but not the past dividends on the preferred, before paying a dividend on the common. D) pays past and current preferred dividends before paying dividends on common stock.

D) pays past and current preferred dividends before paying dividends on common stock. Explanation Current and unpaid past dividends on cumulative preferred stock must be paid before common stockholders can receive a dividend. Bond interest is always paid before dividends. Dividends in arrears on cumulative preferred have the highest priority of dividends to be paid.

One of your customers owns 300 shares of the 5% $100 par cumulative preferred stock issued by the Northern Atlantic Railroad (NAR). The cumulative feature provides that A) all unpaid dividend arrearage must be brought current before a dividend may be paid on NAR's common stock. B) the annual dividend is $5 per year. C) all unpaid dividend arrearage must be brought current before interest may be paid on NAR's subordinated debentures. D) the customer has 300 votes times the number of directors being elected and can vote them in any manner desired.

A) all unpaid dividend arrearage must be brought current before a dividend may be paid on NAR's common stock. Explanation When a preferred stock is cumulative, any prior-year dividends that have been skipped must be paid in full along with the current year's before a dividend payment may be made to common stockholders. Don't confuse the cumulative feature here with cumulative voting that applies to common stock. Any debt security has priority over an equity security. Although it is true that a 5% $100 par stock pays dividends at an annual rate, that has nothing to do with the subject of the question: the cumulative feature.

One way in which incentive stock options (ISOs) differ from nonqualified stock options (NQSOs) is that A) the bargain element of the ISO is an AMT preference item. B) the bargain element of the ISO is reported as wages on the tax returns of the employer and the employee. C) there is a maximum five-year limit for exercise on the ISO, while the time limit on the NQSO is 10 years. D) gains on an ISO are always short term, while those on an NQSO are long term.

A) the bargain element of the ISO is an AMT preference item. Explanation The only true statement here is that the bargain element (the difference between the current market price at the time of exercise and the strike price) of the ISO (but not the NQSO) is one of the preference items for the alternative minimum tax. It is the bargain element of the NQSO that is reported as wages and it is possible, although difficult, to have long-term capital gains on both. Only the ISO has a maximum time limit and it is 10 years, not five.

An ADR is used to A) reduce currency risk when investing in foreign securities. B) facilitate trading in foreign securities in U.S. markets by U.S. citizens living in the United States. C) finance foreign trade in which U.S. citizens are engaged. D) facilitate trading in U.S. securities in foreign markets by U.S. citizens living abroad.

B) facilitate trading in foreign securities in U.S. markets by U.S. citizens living in the United States. Explanation American depositary receipts (ADRs) make trading in foreign securities easier in U.S. markets for U.S. investors.

Which of these is among the advantages of including preferred stock in an investor's portfolio? A) The rate of return is likely to keep pace with inflation. B) There is an opportunity for increased income if the issuer's profits increase. C) Dividends must be paid before any distribution to common stockholders. D) The maturity date is likely shorter than that of debt securities offered by the same issuer.

C) Dividends must be paid before any distribution to common stockholders. Explanation Preferred stock carries a fixed dividend that must be paid before any distribution to common stockholders—hence the name preferred. Disadvantages of owning preferred stock are that the fixed return may not keep up with inflation and, regardless of corporate earnings, the dividend will not change, so there is no hope for increased income. Finally, unlike debt securities, preferred stock is not issued with a maturity date. Nothing has been borrowed so there is no future repayment date.

Which of the following statements regarding ADRs are true? I. They are issued by large domestic commercial banks. II. They are issued by foreign banks. III. They facilitate U.S. trading in foreign securities. IV. They facilitate a foreign investor who wants to trade U.S. securities.

C) I and III Explanation ADRs are issued by large domestic commercial banks to facilitate U.S. investors who want to trade in foreign securities.

Which of the following statements regarding a 100% stock dividend are true? I. The share price is reduced by half. II. The total market value of the outstanding stock decreases. III. The total market value of the outstanding stock may increase or decrease as a result of the split. IV. The number of shares doubles. A) II and IV B) II and III C) I and IV D) I and III

C) I and IV Explanation In a 100% stock dividend, the number of outstanding shares is doubled and the price is reduced by half. The total market value (market cap) of the issuer's stock remains the same.

Which of the following statements about equity securities is not true? A) Preferred stock is usually nonvoting. B) Common stock is less sensitive to interest rate risk than preferred stock. C) Preferred stock is an equity security while common stock is a hybrid. D) Preferred stock pays a fixed dividend.

C) Preferred stock is an equity security while common stock is a hybrid. Explanation Both common and preferred stock are equity securities. Common stock is never referred to as a hybrid; there are times when preferred stock is because of those features that are similar to a debt security. The dividend on preferred stock is fixed, and shares do not have voting rights. The price of a common share generally doesn't fluctuate with changes to interest rates in the same manner as that of preferred stock.

Which of the following statements regarding nonqualified stock options (NQSOs) is correct? A) The NQSO is taxable to the recipient at the time of grant to the extent of the difference between the fair market value of the stock and the grant price. B) The exercise of NQSOs does not create taxable income. C) The NQSO is taxable to the recipient at the time of exercise to the extent of the difference between the fair market value of the stock and the exercise price. D) Unlike incentive stock options, NQSOs are publicly traded.

C) The NQSO is taxable to the recipient at the time of exercise to the extent of the difference between the fair market value of the stock and the exercise price. Explanation The bargain element of an NQSO is taxed to the recipient as salary income at the time the option is exercised. Neither of the employee stock options is publicly traded.

For a profitable and rapidly growing firm, holders of preference shares are least likely to benefit from the firm's growth if the preference shares are A) convertible. B) participating. C) cumulative. D) common.

C) cumulative. Explanation Preferred stock shares, sometimes called preference shares, are cumulative if any dividends in arrears must be paid before the firm pays any common dividends. A profitable and rapidly growing firm is unlikely to be in arrears on its preferred dividends. Just as important, the return on those shares is fixed, and regardless of the growth in the company's earnings, the dividend will remain the same. Participating preferred shares may receive additional dividends if the firm's profits exceed a stated level. Convertible preferred shares can benefit from the firm's growth because of the ability to convert to common shares. The question is asking about preferred stock; do not make a silly error and choose common stock.

ABC Corporation has a 10% noncumulative preferred stock outstanding at $100 par value. Two years ago, ABC omitted its preferred dividend, and last year, it paid a dividend of $5 per share. To pay a dividend to common shareholders this year, each preferred share must be paid a dividend of A) $25. B) $15. C) $5. D) $10.

D) $10. Explanation This stock has a par value of $100 and a dividend rate of 10%. That means the annual dividend will be 10% of the $100 par, or $10. Because this is noncumulative preferred stock, the company must pay only this year's full stated dividend of $10 per share before paying dividends to the common shareholders. Any dividends from previous years that were not paid are ignored. If this had been a cumulative preferred stock, all of the dividends in arrears (past unpaid) would have to be paid before the common shareholders could get a dividend. In that case, it would have been $10 for two years ago, $5 for the balance of last year's dividend, and $10 for this year's (a total of $25).

Which of the following is a risk faced by investors in foreign stocks that is not found when investing in domestic issues? A) Business risk B) Credit risk C) Market risk D) Exchange rate risk

D) Exchange rate risk Explanation An investor who invests in foreign stocks is subject to many of the same risks associated with domestic stock investment, but a unique risk faced by investors in foreign stocks is exchange rate risk, sometimes called currency risk. Someone who invests in foreign stocks has as much invested in the currency of the foreign stock as in the stock itself. Exchange rate risk is not necessarily a bad thing, but it is one more significant factor that investors in foreign stocks must take into account. Credit risk never applies to stock; only debt securities and both domestic and foreign issues are subject to business risk.

Which of the following is a risk faced by investors in foreign stocks that is not found when investing in domestic issues? A) Market risk B) Business risk C) Credit risk D) Exchange rate risk

D) Exchange rate risk Explanation An investor who invests in foreign stocks is subject to many of the same risks associated with domestic stock investment, but a unique risk faced by investors in foreign stocks is exchange rate risk, sometimes called currency risk. Someone who invests in foreign stocks has as much invested in the currency of the foreign stock as in the stock itself. Exchange rate risk is not necessarily a bad thing, but it is one more significant factor that investors in foreign stocks must take into account. Credit risk never applies to stock; only debt securities and both domestic and foreign issues are subject to business risk.

Rule 144 applies to the sale of all of the following except A) unregistered securities by an officer of the issuer. B) registered securities by an officer of the issuer. C) unregistered securities by a nonaffiliated shareholder of the issuer. D) registered securities by a nonaffiliated shareholder of the issuer.

D) registered securities by a nonaffiliated shareholder of the issuer. Explanation Rule 144 applies to the sale of unregistered securities owned by affiliates or nonaffiliates and the sale of control stock. It does not apply to the sale of registered securities by nonaffiliated persons.