65- 12: Types and Characteristics of Equity Securities Including Methods Used to Determine Their Value
Q: The dividend growth model could be used by analyst to comput the value of all of these EXCEPT A. common stock B. ADRs representing common stock in a foreign company C. preferred stock D. none of these are exceptions
C To use the dividend growth model, there must be a possibility of dividend growth. Because preferred stock dividends are FIXED, this tool would not made any sense
Control Stock
Stock owned by a control person -restricted stock -must file a form 144 to sell
An analytical tool used to project the current value of a common stock using projected future dividends is A) the dividend discount model B) the price-to-earnings ratio C) the dividend payout ratio D) the future value computation
A There are two widely accepted forms of common stock price projection using dividends—the dividend discount model and the dividend growth model. U12LO6
Short Interest Theory
A technical analysis theory that examines the ratio of short sales to volume in a stock. Because the underlying stock must be purchased to close out the short positions, a high ratio is considered bullish.
A fundamental analyst would be interested in all of the following EXCEPT A) daily trading volumes on the NYSE B) statistics of the U.S. Department of Commerce on disposable income C) innovations within the automotive industry D) corporate annual reports
A Trading volume interests the technical analyst, who looks at fluctuations in the market, not at fundamental economic values. U12LO6
stock dividend
A way a corporation can pay common stockholders a dividend by giving them additional shares of the stock Ex: an investor owned 100 shares of the stock and the company declared a 20% stock dividend, that investor would receive 20 additional shares bringing the total holding up to 120 shares -Before the distribution, market price was $48/share so investor had $4,800 worth of stock -After the dividend is paid, investor still has $4,800 of stocks but now owns 120 shares, therefore the market price for the stock is now $40/share
A technical analyst would be most interested in which of the following? A) Working capital B) 200-day moving averages C) Capitalization ratios D) Price-to-earnings ratios
B Technical analysts try to predict the market by examining price and volume trends. They expect the market to act in the future as it has in the past. Technical analysts are not interested in the fundamental aspects of a company, such as its financial statement ratios. U12LO6
Which of the following statements regarding nonqualified stock options (NSOs) is CORRECT? A) The NSO 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) Unlike ISOs, NSOs are publicly traded. C) The NSO 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) The exercise of NSOs does not create taxable income.
C The so-called "bargain element" of an NSO is taxed to the recipient as salary income at the time the option is exercised. Neither of the employee stock options is publicly traded. U12LO3
All of the following statements regarding incentive stock options (ISOs) are correct EXCEPT A) if the holding period is satisfied, the gain upon the sale of ISO shares will be a long-term capital gain B) the favorable tax treatment associated with ISOs is lost if the shares acquired through the ISO exercise are sold before 1 year from the date of grant or 2 years from the date of exercise C) upon the exercise of an ISO, income for AMT purposes is created D) the exercise of ISOs does not create taxable income
D The favorable tax treatment is lost if the shares acquired through the ISO exercise are sold before 1 year from the date of exercise or 2 years from the date of grant. You are not taxed upon exercise, only upon sale, but the incentive portion of the option could be considered a preference item for purposes of AMT. U12LO3
Limited Liability of stockholders (both C and P)
In the event of bankruptcy, stockholder's personal assets are NEVER at risk. One cannot be forced to sell any personal assets to help pay the debts of the business -If you invest 5k into a company and they go bankrupt, you can only lose at the most 5k
Julie owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date, what will she own? I. 125 shares II. 100 shares III. Cost basis of $25 IV. Cost basis of $20
I and IV Stock dividends make the number of shares owned increase and the cost per share decrease. The overall value should remain unchanged. 125 shares × $20 = $2,500; 100 shares × $25 = $2,500. Math: 100 shares x $25= $2500/125 shares= 20 cost basis U12LO2
Julie owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date, what will she own? I. 125 shares II. 100 shares III. Cost basis of $25 IV. Cost basis of $20
I and IV Stock dividends make the number of shares owned increase and the cost per share decrease. The overall value should remain unchanged. 125 shares × $20 = $2,500; 100 shares × $25 = $2,500. U12LO2
Risks of Owning Preferred Stock
-market risk -possible loss of purchasing power -interest rate (money) risk -business difficulties that would lead to the reduction or elimination of the dividend and even bankruptcy that would lead to the loss of the investment
One of your customers notices that the short interest on KAPCO common stock is high. When she asks you for an interpretation, you should tell her that this signals A) that a change in interest rates is coming B) a bearish outlook C) a bullish outlook D) a shortage of enough stock to go around
C Even though short interest represents the number of share sold short (typically by bearish investors), technical analysts believe that when it gets high, it is a bullish indicator. Each share that has been sold short must be replaced (covered) at some point. To replace the stock, an investor must go into the market to buy that stock. When all of those short sellers have to buy back the stock they shorted, it puts upward pressure on the price of that stock. U12LO6
The residual right of common stockholders refers to their right to A) receive all announced dividends in accordance with the number of shares held B) vote in elections for the board of directors and in other important business decisions, such as changes to the charter C) claim company assets in bankruptcy after wages, taxes, creditors, and preferred shareholders have been paid D) examine the corporation's annual reports and other reports, and take legal action if irregularities are found
C The residual right of common shareholders refers to their position in the event of bankruptcy. U12LO2
Which of the following factors would be considered by an investor who uses fundamental analysis to value a company's stock? The company's financial condition, as revealed by its income statement and balance sheet General economic conditions, such as employment levels and changes in interest rates Charts showing past movements in stock prices and trading volumes
I and II Fundamental analysis attempts to value stock by examining general economic conditions and the company's financial condition and growth prospects. Technical analysis, on the other hand, tries to identify trends and predict changes in the market. Charts showing past price movements and trading volumes would be used in technical analysis but not in fundamental analysis. U12LO6
Incentive Stock Options (ISO)
Stock options that can be offered only to employees; consultants and outside members of the board of directors are not eligible. -No income recognized when option is granted -No tax due when option is exercised -Tax is due when stock is SOLD --*gain is capital if held at least one year and sold at least two years after grant --Otherwise, ordinary income
Q: A company that has issued cumulative preferred stock: A. pays past and current preferred dividends before paying dividends on common stock B. pays the preferred dividend before paying the coupons due on its outstanding bonds C. pays the current dividends on the preferred, but not past dividends on the preferred, before paying a dividend on the common D. forces conversion of the preferred that is trading at a discount to par, thereby eliminating the need to pay past-due dividends
A The concept behind cumulative preferred stock is that dividends in arrears accumulate and must be paid, along with the current year's dividend, before anything can be paid to common stockholders -Bond interest is always paid before dividends**
An investor who chooses to use preferred stock as an income source instead of bonds would potentially incur which of the following risks? I. Loss of principal II. Price volatility of preferred stock is closely related to interest rates III. Preferred stock cannot be traded as readily as bonds IV. If the stock is callable, the client's income can be suddenly lowered
I, II, and IV Because bonds have seniority over any equity security, there is a greater risk of loss of principal with preferred stock than with bonds. The price volatility of preferred stocks, like bonds, is impacted by interest rate changes. Unlike bonds, however, preferred stock does not have a maturity date. This means that preferred shares may never return to their par value, as bonds do at maturity date. Because the preferred stock may have a callable feature, the company can redeem its shares anytime after the call protection period (if any) is over. This usually happens when interest rates have declined, so the client whose stock was called will not be able to reinvest the proceeds at the same rate and could, therefore, suffer an unexpected drop in income. Preferred shares, particularly those listed on the exchanges, are generally easier to trade than corporate bonds (and certainly no worse). U12LO2
Technical Analysis
-Looking at trends and patterns in past data -LOOKS AT A MARKET
Risks of owning common stock
-Market risk: stock price declines -Business risk: poor management decisions -low priority at dissolution: bonds and preferred stock are paid first at bankruptcy, common stockholders are paid whats left at the end
One method used by some analysts to estimate the future value of a stock is the dividend growth model. This model would probably be most useful in the case of A) a small-cap stock B) a preferred stock C) a AAA corporate bond D) a large-cap stock
D The dividend growth model is a method to value the common stock of a company on the basis of assumed constant growth of dividends in the future. Therefore, it can only be applied to a corporation whose dividends might be expected to increase. It is far more likely that a large-cap stock will be paying dividends than a small-cap. Bonds don't pay any dividends, and in any event, their interest, just like the dividends on preferred stock, is fixed; there is no growth possible. U12LO6
Odd Lot Theory
Theory that the ODD LOT investor who trades in less than 100-share quantities is usually WRONG and that profits can be made by acting contrary to odd-lot trading patterns.
American Depository Receipts (ADRs)
Used to facilitate domestic trading of foreign securities -Because everything is in US dollars and in English, ADRs make trading in foreign securities much easier for those who live here -Risks: currency risk and market risk
Breakout
When stock's price or volume exceeds previously recorded high or low (or resistance or support level) or some other predetermined criteria. Also called "Penetration." -breakout thru resistance= good buying opportunity -breakout thru support= good selling opportunity
Nonqualified Stock Options (NQSO)
-Treated as a form of compensation -Can be sold to employees, board members, suppliers -the difference between the market price at the time of exercise and the striking price is reported as wages on the tax returns of the employer and employee -employee is taxed as ordinary income while the company receives a tax reduction as salary expense for the difference between the current market price and the strike price
Benefits to owning common stock
-a hedge against inflation -voting rights -dividends
Benefits to owning preferred stock
-fixed income from dividends -prior claim ahead of common stock -
Types of Preferred stock
1. Straight -pays the stated dividend payment -missed dividends are not paid to holder 2. Cumulative -accrues payments due in the event dividends are reduced/suspended -provides steady income 3. Callable Preferred -typically has highest state dividend rate -company can buy back @ stated price after specified date (refinance) 4. Convertible Preferred -generally issued with a lower stated dividend rate because the investor can convert it to common shares, price fluctuates w/ CS price 5. Adjustable Rate Preferred -dividends are tied to rates of other interest rate benchmarks -price stable -LEAST appropriate choice if looking for income`
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) $10.00 B) $5.00 C) $25.00 D) $15.00
A 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 shares. U12LO2
KAPCO common stock is listed on the New York Stock Exchange. 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 6-month holding period D) may sell immediately without restriction
A 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. U12LO4
Which of the following statements best describes cumulative preferred stock? A) 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. C) Owners are allowed to vote for directors using the cumulative voting procedures. D) Owners receive an extra dividend, along with common shareholders, in addition to the preferred dividend.
B 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. U12LO2
Which of the following statements regarding preemptive rights is TRUE? A) Common stockholders do not have the right to subscribe to a rights offering. B) Both common and preferred stockholders have the right to subscribe to a rights offering. C) Preferred stockholders do not have the right to subscribe to a rights offering. D) Neither common nor preferred stockholders have the right to subscribe to a rights offering.
C Preferred stockholders have a preference as to liquidation and distribution of dividends, but the right to maintain a proportionate interest in the company only applies to common stock. U12LO2
An analyst uses the dividend growth model to assist in determining appropriate stocks to recommend. This analyst would consider all of the following factors EXCEPT A) growth of the dividend B) required rate of return C) market capitalization D) current dividend
C The classic definition of the dividend growth model is "a stock valuation model that deals with dividends and their growth, discounted to today." The market capitalization is the number of outstanding shares multiplied by the current market price per share and has nothing to do with the company's dividend policies. U12LO6
When reviewing potential securities to select for an investor's portfolio, a technical analyst would be most likely to evaluate A) the management tenure B) the price-to-book ratio C) the price-to-earnings ratio D) the daily trading volume
D A technical analyst charts price and volume over time. The other choices are of interest to a fundamental analyst. U12LO6
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) common stock B) adjustable rate preferred stock C) convertible preferred stock D) straight preferred stock
D 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. U12LO2
One of the rights of those owning common stock is the opportunity to vote on issues brought up at the corporation's annual meeting. To be eligible to cast a vote, A) the company must be current on its dividends to preferred stockholders B) the stockholder must be a natural person C) the stock must be paid for in full before the annual meeting D) ownership must be established by the record date
D Only stockholders who are on the company's books by the record date are eligible to vote. U12LO2
Support and Resistance Levels
Support -Price where the stock price bottoms -once it gets that low, there is an imbalance between buyers and sellers (more investors seeking to buy than sell) -Price begins to RISE Resistance -Price where stock is at a high enough level where there are now more sellers than buyers -stock no longer rises **SUPPORT IS WHEN YOU STOP FALLING **RESISTANCE IS WHEN YOU CAN'T GO ANY HIGHER
Advance Decline Theory
Technical indicator that measures the strength of the market by comparing the number of stocks that increase and decrease. It shows the general direction and breadth of a market movement on a given day. A good indicator of the strength of a bull or bear market.
Dividend Discount Model
a model that states that the current market value of a stock should be equal to the present value of all future dividends
Preferred Stock
a nonvoting share of ownership in a corporation that pays a fixed dividend -more similar to debt securities -price fluctuates with changes in interest rates
Dividend Growth Model
model that assumes the amount of the annual dividend will grow at a constant rate
Common Stock
the most basic form of ownership, including voting rights on major issues, in a company
Fundamental Analysis
the study of a company's accounting statements and future prospects to determine its value -LOOKS AT A COMPANY -Dividend Models (value of stock can be determined based on current or anticipated dividend: discount model and growth model
