SIE Unit 2.2 Quiz

A customer owns cumulative preferred stock (par value of $100) that pays an 8% dividend. The dividend has not been paid this year and was missed in the two previous years. If the company wants to pay a dividend to common shareholders, how much must the company pay this customer per share first?

$24 If the company is going to pay a common stock dividend, it must pay the preferred dividends first, including all dividends in arrears (missed). There are $16 due in back dividends for the two years missed, in addition to $8 this year, for a total of $24.

Which of the following statements is correct concerning currency risk when investing in an American depositary receipt (ADR)? A) U.S. investors are protected from currency risk by the underlying foreign corporation. B) Currency risk is eliminated because the securities are dollar denominated. C) Currency risk is still a factor when purchasing an ADR. D) U.S. investors are protected from currency risk by the depositary bank.

Currency risk is still a factor when purchasing an ADR. ADRs are issued and pay dividends in U.S. dollars eliminating the complications of currency conversion. However, ADRs are still subject to currency risk. Why? The company pays dividends in its home currency, and the issuing bank pays out those dividends in U.S. dollars. When the exchange rate changes, the amount these dividends (in U.S. dollar terms) will fluctuate as well. Also, the value of the ADR itself will rise and fall with the value of the underlying foreign stock which is partially due to currency swings.

What is the primary benefit for an American investor when purchasing an American depositary receipt (ADR)? A) Hedging currency risk B) Tax-deferred dividends C) Diversification D) Exemption from U.S. taxation

Diversification ADRs are a type of equity security designed to simplify foreign investing for Americans. ADRs provide Americans with an easy way to invest in foreign companies that might otherwise be difficult or impossible to own. This overseas exposure provides investors with additional diversification within their portfolio.

Why would a foreign corporation want to see American depositary receipts issued for its common stock? A) Ease of company operations in the U.S. B) Easier access to U.S. capital markets C) Reduce domestic taxation D) The option to operate under U.S. law

Easier access to U.S. capital markets ADRs make investing easier for U.S. investors and make accessing U.S. capital markets easier for the foreign corporation. The company must still operate under the laws of the nation in which it is located.

For registered shares held by an affiliate (known as control stock), which of the following applies? A) Six-month holding period, with sales allowed freely thereafter B) Six-month holding period, with volume limits thereafter C) No holding period, but volume limits always apply D) No holding period or any volume restrictions

No holding period, but volume limits always apply Control stock would be registered shares held by an affiliate. There is no holding period, but there will always be volume limits for as long as the individual is an affiliate.

Which of these is an equity security? A) Preferred stock B) Municipal bonds C) Debentures D) Mortgage bonds

Preferred stock Common and preferred stock are examples of an equity security. Bonds of any type by comparison are certificates of indebtedness—debt instruments.

For restricted stock (unregistered) held by an affiliate (insider), which of the following applies? A) No holding period, but volume limits always apply B) No holding period or any volume restrictions C) Six-month holding period, with sales allowed freely thereafter D) Six-month holding period, with volume limits thereafter

Six-month holding period, with volume limits thereafter For restricted stock (unregistered) held by an affiliate (insider), there is a six-month holding period, with volume limits applicable thereafter. The volume limits would remain in effect for as long as the individual is an affiliate.

Your customer has owned a position in a London-based corporation's American depositary receipts (ADRs) for several years and has now sold them for a substantial profit. What are the tax implications of the sale? A) The gains are subject to the capital gains tax as long-term capital gains. B) The gains may be subject to withholding by the home country of the underlying issuer. C) The gains will be taxed as ordinary income. D) The gains will be taxed as short-term gains because long-term gains rules do not apply to ADRs.

The gains are subject to the capital gains tax as long-term capital gains. Any trading profits (capital gains) from the ADR would only be taxable in the United States. Because the position was maintained for more than one year, long-term capital gains rules would apply.

What is the primary purpose of an issuer sponsoring an American depositary receipt (ADR)? A) These securities are created to facilitate foreign investment in U.S. companies. B) These securities are created to attract a U.S. investor base. C) These securities permit the issuer to avoid Securities and Exchange Commission (SEC) jurisdiction. D) These securities are created to provide tax relief for U.S. investors.

These securities are created to attract a U.S. investor base. ADRs are a type of equity security designed to simplify foreign investing for Americans. An ADR is created when common shares are purchased in the foreign company's home market. These shares are then deposited in a foreign branch of a U.S. bank and a receipt (the ADR) is created. The ADR trades in the U.S and is denominated in U.S. currency making the process of buying a foreign stock much easier for an American investor. ADRs are subject to U.S. securities regulations.

An investor who is an affiliate of XYZ Corporation holds shares of restricted XYZ stock. These shares have A) a 30-day holding period and are subject to volume limits for as long as the investor is an affiliate. B) a six-month holding period and are subject to volume limits for as long as the investor is an affiliate. C) no holding period but are subject to volume limits for as long as the investor is an affiliate. D) no holding period, nor are they subject to any volume limitations currently or in the future.

a six-month holding period and are subject to volume limits for as long as the investor is an affiliate. Rule 144 mandates that restricted shares held by an affiliate are subject to a six-month holding period and will be subject to volume restrictions (limits) for as long as the individual continues as an affiliate of the corporation.

Past-due dividends on cumulative preferred shares A) accumulate on the company's books until paid. B) are written off as nonpayable. C) can never be paid until common shareholders receive a dividend. D) must be reallocated to common shareholders.

accumulate on the company's books until paid. Past-due dividends on cumulative preferred stock accumulate on the company's books until the corporation's board of directors decides to pay them. When the company resumes dividend payments, cumulative preferred stockholders receive current dividends plus the total accumulated dividends in arrears (those that were missed) before any dividends may be distributed to common stockholders. Common shareholders have no claim on preferred dividends.

While preferred shares tend to be less volatile than common shares, one type of preferred is noted as being even more stable in price than the others. This would be:

adjustable rate. Because the dividend payment adjusts to current interest rates, the price of the stock remains relatively stable. In other words, it is the return that fluctuates rather than the price.

The common stock of a U.S. corporation and an American depositary receipt (ADR) issued in the United States share all of the following types of risk except A) market risk. B) currency risk. C) regulatory risk. D) business risk.

currency risk. An ADR represents a foreign stock and is subject to currency risk, even if the ADR is issued in the U.S. Like all equities, it is subject to market and business risk and is certainly exposed to regulatory risk in its home country.

The growth potential in the price of preferred shares is generally considered to be A) less than that of the issuer's common shares. B) greater than that of the issuer's common shares. C) unrelated to the financial well-being of the issuer. D) no different than that of the issuer's common shares.

less than that of the issuer's common shares. While the growth potential of both common and preferred shares can be tied to a company's financial well-being, preferred share growth is generally less than that of the common shares. The trade-off is that the preferred shares have preference with dividends received, enjoy a fixed rate of return via those dividends, and have a priority claim over common shareholders in the event of bankruptcy and the dissolution of assets.

A company that has issued noncumulative preferred stock A) pays the preferred dividend before paying the interest due on its outstanding bonds. B) pays current preferred dividends before paying dividends on common stock. C) pays in arrears and current 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.

pays current preferred dividends before paying dividends on common stock. There are no in-arrears dividends on noncumulative preferred. Current and unpaid past (in arrears) dividends on cumulative preferred stock must be paid before common stockholders can receive a dividend. Bond interest is always paid before dividends.

A corporation that has issued cumulative preferred stock A) pays only current dividends with no liability for missed or past-due dividends. B) pays past and current preferred dividends before paying dividends on common stock. C) pays only the current dividends on the preferred, before paying a dividend on the common and then pays any past-due dividends. D) pays the preferred dividend before paying the interest payments due on its outstanding bonds.

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

The common stock of a U.S. corporation and an American depositary receipt (ADR) issued in the United States share significant exposure to all of the following types of risk except A) business risk. B) social risk. C) political risk. D) market risk.

political risk. An ADR represents a foreign stock and is subject to political risk, even if the ADR is issued in the U.S. The United States is considered a very stable place to invest with little political risk. Like all equities, it is subject to market risk, business risk, and social risk like any corporation.

Callable preferred stock is advantageous to the issuing company because it allows the company to A) replace a higher, fixed-rate issue with a lower issue after the call date. B) issue fixed-rate securities at a yield lower than usual. C) take advantage of higher interest rates. D) call in the stock at less than par value and capture the difference as income.

replace a higher, fixed-rate issue with a lower issue after the call date. By issuing a callable preferred stock, a corporation can call in a high dividend payment issue and replace it with a lower one when interest rates have fallen. This feature allows the company to take advantage of reduced interest rates by calling in high-rate preferred issues and replacing them with lower ones.

The rate on an adjustable preferred stock would most likely be indexed to A) the Treasury bill (T-bill) rate. B) the Consumer Price Index (CPI). C) the Producer Price Index (PPI). D) the Dow Jones Industrial Average (DJIA).

the Treasury bill (T-bill) rate. The dividend on an adjustable-rate preferred stock is tied to a particular benchmark interest rate, and the Treasury bill rate is a common benchmark. The CPI, the PPI, and the DJIA are not interest rates.

When shareholders owning participating preferred shares receive the additional participating amount, this was determined by:

the board of directors (BOD). Additional dividends in profitable years payable to participating preferred shareholders is at the direction of the BOD. Just as a dividend is declared, the BOD would declare any participating dividend to be paid.