Ch.1 quiz missed ** REVIEW

A company's common stock is selling in the market at a "multiple of 15". If the market price of the common stock is currently $10, what is the earnings per share?

$.67 When a stock is selling at a "multiple" of 15, this means that the market price is 15 times the current earnings per share. Since the market price is at $10 and the P/E ratio is 15, earnings per share is $.67.

XYZ Company has issued 10%, $100 par non-cumulative preferred stock. Two years ago, XYZ omitted its preferred dividend. Last year, it paid a preferred dividend of $5 per share. This year, XYZ wishes to pay a common dividend. In order to make the distribution to common shareholders, each preferred share must be paid a dividend of:

$10 Since the preferred stock is noncumulative, to make a dividend distribution to common shareholders, the company need only make this year's preferred dividend distribution. The stated dividend rate on the preferred is 10% based on $100 par, so $10 of preferred dividends must be paid per share. If this preferred were cumulative, then all omitted dividends must be paid before a distribution can be made to common. Please note that almost all preferred stock issues are cumulative - but non-cumulative issues must still be known for the exam.

Common stockholders do not have which right?

The right to review internal Board of Director communications

Which security of the same issuer is likely to give the highest current yield?

non-convertible preferred stock Warrants give no yield. Common stocks give the lowest yields since there is direct growth potential in the price of the stock as reported earnings increase. Convertible preferred yields are higher than common yields but not as high as non-convertible yields. A non-convertible preferred stockholder gets a fixed rate of return without any growth potential. A convertible preferred stockholder can convert to common if the common's price rises, so growth potential is included. Because of this, yields for convertible preferred are lower than for non-convertible preferred.

Common dividends are paid:

quarterly on outstanding shares Common dividends are usually declared and paid quarterly. Dividends are only paid on outstanding shares - defined as issued shares minus Treasury stock.

XYZZ ADR represents 10% of the value of an XYZZ ordinary share. The ordinary shares trade on the London Stock Exchange, where the current price is 400 British Pounds (BP). The current exchange rate for the British Pound against the U.S. Dollar is $1.40. The ordinary share pays an annualized dividend of 12 BP, with payment made semi-annually. The XYZZ ADR is listed on the NYSE. If a customer places an order to buy $560,000 of the ADR on the NYSE, how much will the customer receive in each dividend payment?

$8,400 Because the XYZZ ordinary share trades for 400 BP in London, and the BP is worth $1.40, each ordinary share is worth 400 x $1.4 = $560. The ADR created for the U.S. market is 1/10th of this amount, or $56 per U.S. ADR. A customer who invests $560,000 will buy $560,000 / $56 = 10,000 ADR shares. The annual dividend rate per ordinary share is 12 BP, so the semi-annual payment is 6 BP. Since the ADR is worth 1/10th of an ordinary share, this becomes .6 BP per ADR share x $1.40 exchange rate = $.84 per ADR share x 10,000 shares = $8,400.

XYZZ ADR represents 10% of the value of an XYZZ ordinary share. The ordinary shares trade on the London Stock Exchange, where the current price is 400 British Pounds (BP). The current exchange rate for the British Pound against the U.S. Dollar is $1.40. The ordinary share pays an annualized dividend of 12 BP. The XYZZ ADR is listed on the NYSE. If a customer places an order to buy $560,000 of the ADR on the NYSE, the customer will buy how many shares of the ADR?

10,000 Because the XYZZ ordinary share trades for 400 BP in London, and the BP is worth $1.40, each ordinary share is worth 400 x $1.4 = $560. The ADR created for the U.S. market is 1/10th of this amount, or $56 per U.S. ADR. A customer who invests $560,000 will buy $560,000 / $56 = 10,000 ADR shares.

A customer holds 100 shares of ABC Corp $100 par non-convertible preferred stock. If ABC declares and pays a 10% common stock dividend, then as of the payable date, the customer will now have:

100 shares of ABC preferred stock If ABC declares and pays a 10% "common" stock dividend, the customer who holds non-convertible or convertible preferred stock would not benefit in any way. Thus, due to the payment of a common stock dividend, the customer would still have 100 shares of the non-convertible preferred stock.

PDQ Company $10 par common stock is currently trading at $40. PDQ is currently paying a common dividend of $.20 per share quarterly. The current yield of PDQ stock is:

2.0%

A customer buys 100 shares of preferred at $51 per share. The par value is $50. The dividend rate is 8%. Each dividend payment would be:

200 The annual rate is 8% x $50 par value = $4 per share x 100 shares = $400. Since preferred dividends are paid semi-annually, each payment is for $200.

A company wants to raise capital using a security that will give the subscribers voting rights. What should the company issue?

Common stock Only common stockholders have the right to vote. Preferred stockholders and bondholders do not have voting rights. Warrant holders also do not have voting rights.

If a corporation wishes to sell additional shares, which of the following persons can subscribe using pre-emptive rights?

Common stockholders Only common stockholders have pre-emptive rights. Holders of senior securities (preferred stock and bonds) do not have pre-emptive rights; nor do warrant holders since they do not own the common stock unless the warrants are exercised.

The market price of common stock will be influenced by which of the following?

Expectations for future dividend payouts by the company The market price of common stock is determined by investor expectations about the future of the company. Par value, book value and the number of Board of Director seats have no direct bearing on the market price of the common.

Callable preferred stock is likely to be redeemed by the issuer if: If interest rates fall, issuers can "call in" old high rate preferred and replace it by selling new preferred at the lower current rates. Thus, calls take place when interest rates have fallen.

Interest rates fall

American Depositary Receipts would trade on all of the following exchanges EXCEPT the:

London Stock Exchange

What term would apply to Authorized Stock?

Par Value Par value is the term that applies to all stock, whether it is Authorized, Issued, Outstanding or Treasury.

During periods of stable interest rates, which type of preferred stock will have the greatest price volatility?

Participating. Participating preferred gives the preferred shareholder the right to participate with common in any "extra" dividends declared by the Board of Directors. If these extra dividend payments are made, this can cause the preferred stock price to rise even though interest rates have not fallen. Virtually all preferred stock is cumulative - if the company misses preferred dividend payments, then before it can pay a common dividend, it must make up all unpaid preferred dividend payments. Callable preferred gives the issuer the right to call in the preferred at a pre-established price, which the issuer would do if market interest rates fell. This would tend to suppress the upward movement of the stock price to no more than the call price as market interest rates fell. In a period of stable interest rates, the issuer has no reason to call the preferred stock. Adjustable rate preferred adjusts the dividend rate, tied to the movements of a market interest rate index, so as market rates move up, the dividend rate moves up and vice versa. Therefore, in a period of stable interest rates, the dividend rate will not change, nor will the price (unless the credit quality of the issuer deteriorates).

Which statement is TRUE regarding preferred stock payments?

Preferred dividends are usually higher than those paid to common Preferred dividends are typically fixed and are generally higher than those paid to common stockholders. Preferred dividends (NOT interest) are, in most cases, paid semi-annually, as compared to common stock dividends that are paid quarterly.

All of the following are types of preferred stock EXCEPT:

Refundable There is no such thing as refundable preferred stock. Participating preferred (also known as performance preferred) allows the holder to receive additional dividend distributions from the issuer if the issuer is having a good year. Cumulative preferred "accumulates" any unpaid dividends. Before a common dividend may be paid, all accumulated dividends must be paid to cumulative preferred shareholders.

American Depositary Receipts pay dividends in:

U.S. Dollars American Depositary Receipts pay dividends in U.S. dollars only. The dividends are declared and paid in the foreign currency by the issuer. The bank that issues the ADR exchanges the dividend into U.S. dollars and pays this to the U.S. ADR holders.

A middle-aged widowed customer has an investment objective of stable income and wants minimal market and liquidity risk. What type of preferred stock would be the best recommendation?

Variable rate preferred Variable rate preferred has a dividend rate that is tied to a market rate of interest, and the dividend rate varies as that rate varies. When market interest rates rise, the dividend rate rises; when market interest rates fall, the dividend rate falls. Because the dividend rate varies, the price of the security stays right at par value and has minimal market risk. In contrast, any fixed income security, which includes the other types of preferred stock, is subject to market risk. When market interest rates rise, the value of any fixed rate security must fall, making its yield competitive with current market rates. Finally, all preferred stock has minimal liquidity risk. Preferred shares are listed and trade, so the shares can be sold readily at low cost.

All of the following statements are true regarding warrants EXCEPT:

Warrant holders have pre-emptive rights Warrants are an equity-related security that give the holder the right to buy the stock of that issuer at a fixed price. The exercise price is much higher than the market price of the common at the time of issuance, so the stock must rise in price for the warrant to have real value. They are typically attached by issuers to debt and preferred stock offerings (securities that are "senior" to the common stock of the issuer) to make the securities more attractive to purchasers. Warrant holders do not receive dividends, nor do they have other shareholder rights such as the right to vote or the pre-emptive right. Warrants are much cheaper than the actual stock, because they only have value if the underlying stock price rises. Thus, they give the holder greater leverage (gain potential as a percentage of capital contributed) if the common stock does appreciate than actually purchasing that stock.

Corporate dividend payments can be made in all of the following ways EXCEPT:

listed options of that company COMPANIES CAN ISSUES PAYMENTS IN THE FORM OF *DIVIDEND SHARES OF *OTHER COMPANIES. Corporations can pay dividends as cash or in stock, and can also distribute products produced by that company as a dividend to shareholders. For example, Proctor & Gamble used to send soap products to shareholders. A company can make a distribution of additional shares of that company (a stock dividend); or can issue a dividend consisting of shares of another company (typically a wholly owned subsidiary whose shares are distributed to owners of the parent company). Corporations cannot make dividend distributions consisting of listed options in that company, since the contracts are created and issued by the Options Clearing Corporation - NOT the company.

If interest rates fall, issuers most likely will call:

preferred issues with above market interest rates If interest rates fall, issuers most likely will "call in" old high rate preferred and replace it by selling new preferred at the lower current rates. The "call premium" is any amount that the issuer will pay the preferred stockholder above par value as "extra" compensation for calling in the issue. Issuers are more likely to call in issues with low call premiums (lower extra cost to the issuer) than call in issues with high call premiums (higher extra cost to the issuer).

Stockholder approval is needed if a corporation wishes to:

split its stock 2 for 1 Stockholder approval is needed for a stock split, because it changes the par value of the stock. The state in which the company is incorporated typically requires shareholder approval of a par value change. In contrast, dividend decisions, either in cash or stock, do not require shareholder approval because they are "paid" out of retained earnings and do not affect par value per share. They are made solely by the Board of Directors of the company. The repurchase of shares for Treasury will boost earnings per share, because there will be fewer shares outstanding. This boosts the value of the existing common shares, so no shareholder approval is required. This is another decision that is made solely by the Board of Directors.