Unit 1 - Types and Characteristics of Equity Securities

A customer owns cumulative preferred stock (par value of $100) that pays an 8% dividend. The dividend has not been paid this year or for the two previous years. How much must the company pay the customer per share before it may pay dividends to the common stockholders? A) $24 B) $0 C) $16 D) $8

A) $24 If the company is going to pay a common stock dividend, it must pay the preferred dividends first. A cumulative preferred stockholder must also receive all dividends in arrears. There are $16 due in back dividends, in addition to $8 this year, for a total of $24. LO 1.c

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

A) common or preferred stock. 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. LO 1.a

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 immediately without restriction. D) may sell under Rule 144 only after a six-month holding period.

A) may sell immediately subject to Rule 144 volume limitations. 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. LO 1.e

Holders of each of the following are creditors EXCEPT: A. investors owning preferred stock B. investment companies owning corporate bonds C. corporations owning municipal bonds D. states owning US government bonds

A. investors owning preferred stock

Which of the following statements about dividends on common stock is not true? A) Only those who are owners of the stock on the record date will receive dividends. B) Corporations are contractually obligated to pay dividends to their shareholders each year. C) Dividends may be paid in cash, property, or stock. D) Dividends represent a pro rata distribution of corporate profits to shareholders.

B) Corporations are contractually obligated to pay dividends to their shareholders each year. Dividends are the share of a corporation's profits that the corporation pays to shareholders as owners of the corporation. Dividends are not paid to shareholders automatically, and shareholders have no contractual right to receive dividends. Instead, dividends must be declared by the corporation's board of directors. The board of directors may elect to pay a dividend in cash, property, or stock. LO 1.b

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

B) Interest rate 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. LO 1.f

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

C) I and III ADRs are issued by large domestic commercial banks to facilitate U.S. investors who want to trade in foreign securities. LO 1.f

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

A) Common stocks 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. LO 1.b

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

C) I and II Control persons are always subject to volume limitations. LO 1.e

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

D) Preferred stock is an equity security while common stock is a hybrid. 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. LO 1.a

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

D) have voting rights. It is rare to find a preferred stock with voting rights and ever rarer to find a common stock without them. Both receive dividends when, and if, declared by the BOD and they are usually paid quarterly. Both are equity securities, and preferred has the prior claim. LO 1.b

Limited liability regarding ownership in a US corporation means all of the following EXCEPT: A. investors might lose more than the amount of their investment B. investors might lose their investment C. creditors of the corporation cannot seek relief from the shareholders D. investors are not liable to the full extent of their personal property

A. investors might lose more than the amount of their investment

Which of the following statements regarding ADRs are true? The securities are vehicles used to facilitate U.S. trading of foreign securities. Dividends are received in the foreign currency. Holders have foreign currency risk. The receipts are issued by a foreign branch of a domestic bank. A) II and IV B) I and III C) I, II, and III D) I, III, and IV

B) I and III ADRs are vehicles that facilitate U.S. trading of foreign securities. They are issued in English in the United States by domestic banks. Dividends are declared in the foreign currency but are payable to holders in U.S. dollars, which means that ADR holders are subject to foreign currency risk. LO 1.f

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

C) I and II Control persons are always subject to volume limitations. LO 1.e

The residual right of common stockholders refers to their right to A) vote in elections for the board of directors and in other important business decisions, such as changes to the charter. B) receive all announced dividends in accordance with the number of shares held. 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) claim company assets in bankruptcy after wages, taxes, creditors, and preferred shareholders have been paid. The residual right of common shareholders refers to their position in the event of bankruptcy. LO 1.b

Which of the following have equity positions in a corporation? Common stockholders Preferred stockholders Convertible bondholders Mortgage bondholders A) I and III B) II and IV C) I and II D) III and IV

C) I and II Common and preferred stockholders have equity or ownership positions. Bondholders (mortgage or otherwise) are creditors, not owners. LO 1.a

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) Market risk C) Credit risk D) Exchange rate risk

D) Exchange rate risk 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. LO 1.f

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

D) liquidity. 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. LO 1.f

Which of the following statements about the restricted stock is CORRECT? A. It must be held a minimum of one year before resale B. Sales must be accompanied by Form R C. Volume limits generally apply to sales by control (affiliated) persons D. The restrictions apply only to those defined as control persons

C. Volume limits generally apply to sales by control (affiliated) persons

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

A) facilitate trading in foreign securities in U.S. markets by U.S. citizens living in the United States. American depositary receipts (ADRs) make trading in foreign securities easier in U.S. markets for U.S. investors. LO 1.f

Which of the following statements regarding rights is TRUE? A. Common stockholders would not generally receive preemptive rights B. Preferred stockholders would not generally receive preemptive rights C. Both common and preferred stockholders would generally receive preemptive rights D. Neither common nor preferred stockholders would generally receive preemptive rights

B. Preferred stockholders would not generally receive preemptive rights

Owners of a corporation's equity securities A. are always assured dividends if the company is profitable B. are creditors of the corporation C. have limited liability D. have the right to vote their shares

C. have limited liability

Among the benefits of owning common stock are I. historical hedging against inflation II. voting rights III. access, as owners, to information about corporate earnings before the general public IV. dividends A. I and II B. I, II, and IV C. II and IV D. I, II, III, and IV

B. I, II, and IV I. historical hedging against inflation II. voting rights IV. dividends

If a customer owns 7% of a publicly traded company's stock and his spouse owns 6% and wants to sell her shares, which of the following statements is true? A) The spouse is an affiliate and Rule 144 applies. B) The spouse is not an affiliate and Rule 144 does not apply. C) The spouse is an affiliate and Rule 144 does not apply. D) The spouse is not an affiliate and Rule 144 applies.

A) The spouse is an affiliate and Rule 144 applies. Together, the client and spouse own 13% of the company's stock, so the spouse is considered an affiliate and is bound by Rule 144. If there is a 10% or more ownership interest among members of an immediate family living at the same residence, then all members are considered control persons (affiliates) subject to Rule 144. For exam purposes, assume that spouses share the same residence. LO 1.e

Which of the following statements concerning equity securities is not correct? A) 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. 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) Common stock is an equity security representing an ownership interest in a corporation.

B) Equity securities represent a lending interest in a corporation. 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. LO 1.a

If a woman owns 9% of the common shares of XYZ and her spouse owns 2% and wishes to sell his shares, which of these is true? He is considered an affiliate. He is not considered an affiliate. He must file a Form 144 to sell. He does not have to file a Form 144 to sell. A) II and IV B) II and III C) I and IV D) I and III

D) I and III If a married couple (either individually or jointly) owns a combined total of 10% or more of a corporation's voting shares, they are considered affiliates and are subject to the requirements of SEC Rule 144. For exam purposes, assume spouses share the same residence. LO 1.e

ADRs are used to facilitate A. foreign trading of domestic securities B. foreign trading of US government securities C. domestic trading of US government securities D. domestic trading of foreign securities

D. domestic trading of foreign securities

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

B) I and IV 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. LO 1.b

A client is considering the purchase of American depositary receipts (ADRs). She is looking to further diversify her portfolio. Which of the following is not a feature of this type of investment vehicle? A) ADRs are traded on exchanges and the OTC markets. B) They are not subject to exchange rate, or currency, risk. C) Information regarding the foreign company is easily attainable. D) ADRs are denominated and pay dividends in U.S. dollars.

B) They are not subject to exchange rate, or currency, risk. Even though ADRs are denominated in U.S. dollars, they are subject to exchange rate, or currency, risk. In order to trade in the U.S. markets, information about the foreign company must be available to investors. ADRs representing the best-known companies typically trade on the NYSE or the Nasdaq stock market while lesser companies trade OTC. LO 1.f

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

B) a certificate representing ownership of a foreign security that is on deposit at a U.S. bank. 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. LO 1.f

Four years ago, Susan was granted enough nonqualified stock options (NQSOs) to purchase 500 shares of her employer's stock at $20 per share. Assuming Susan exercises all of her options when the fair market value of the stock is $30 per share and her ordinary income tax rate at the time is 28%, how much income tax will be due? A. $280 B. $1,400 C. $5,600 D. $8,400

B. $1,400

An investor owns 15% of the stock of a publicly traded company. This investor's spouse owns 5% of the stock of the same company. If the spouse wishes to sell the shares representing that 5% ownership, which of the following statements is TRUE? I. Both the investor and the spouse are control persons II. The investor is a control person, while the spouse is not III. The spouse must file a Form 144 IV. The investor must file a Form 144 A. I and III B. I and IV C. II and II D. II and IV

A. I and III I. Both the investor and the spouse are control persons III. The spouse must file a Form 144

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

C) it represents ownership in a corporation. 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. LO 1.a

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

C) I and IV 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. LO 1.b

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) common. B) convertible. C) participating. D) cumulative.

D) cumulative. 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. LO 1.c

Which of the following are subject to the holding period requirements of Rule 144 of the Securities Exchange Act of 1934? Registered securities held by a control person Unregistered securities held by a noncontrol person Registered securities held by a noncontrol person Unregistered securities held by a control person A) II and III B) I and III C) II and IV D) I and IV

C) II and IV The holding period requirement of Rule 144 applies to unregistered securities, no matter who the owner is. LO 1.e

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

C) a U.S. depositary bank. 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. LO 1.f

An investor who has purchased preferred stock with the goal of receiving steady quarterly income would be most interested in the: A. seniority of the stock compared to other securities B. ability of the company to continue paying the stated dividend C. voting power of the shares D. par value of the shares

B. ability of the company to continue paying the stated dividend

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

C) resale. 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. LO 1.e

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

A) no effective change in the value of the position. 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. LO 1.b

A company that has issued cumulative preferred stock A. pays past and current preferred dividends before paying dividends on common stock B. pays the current 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. forces conversion of the preferred that is trading at a discount to par, thereby eliminating the need to pay past-due dividends

A. pays past and current preferred dividends before paying dividends on common stock

Which two of the following risks would be of greatest concern to the holder of an ADR? I. Currency II. Liquidity III. Market IV. Purchasing power A. I and II B. I and III C. II and IV D. III and IV

B. I and III I. Currency III. Market

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

D) Interest rate 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. LO 1.f

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

C) no effective change in the value of the position. 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. LO 1.b

Julie owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date, what will she own? 125 shares 100 shares Cost basis of $25 Cost basis of $20 A) II and III B) I and IV C) I and II D) II and IV

B) I and IV Remember that the ex-date is the first day on and after which a purchaser of a stock is not entitled to a previously declared dividend (cash or stock). That means the owner of the stock on and after the ex-date is the one who receives the cash or, in this case, the additional stock. The payment of a stock dividend causes the number of shares owned to increase while the cost per share decreases. The total value of the position will always remain unchanged. Julie had 100 shares at $25 per share, or $2,500, and now has 125 shares × $20 = $2,500. LO 1.b

One of the features of convertible preferred stock is that A) the owner has the opportunity to participate in the growth of the company. B) the dividend is paid ahead of all other securities. C) the holder is able to select the conversion price. D) the owner has the opportunity to convert the stock into the issuer's bonds.

A) the owner has the opportunity to participate in the growth of the company. Any convertible security, preferred stock, or debenture is convertible into the issuer's common stock. As a result, if the business is successful, the common stock's price will rise to the point where conversion is a wise idea. Although the investor can generally select when to convert, the conversion price or ratio is set at the time of issuance. Interest on debt securities is paid before the dividends on any stock. When it comes to preferred stock, there is frequently a pecking order, such as a prior lien preferred or first preference preferred that would come ahead of the other preferred shares. LO 1.c

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) straight preferred stock. C) adjustable rate preferred stock. D) convertible preferred stock.

B) straight preferred stock. 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. LO 1.c

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. 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. LO 1.a

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

C) limited liability. 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. LO 1.a

Which of the following statements regarding nonqualified stock options (NSOs) is correct? A) Unlike ISOs, NSOs are publicly traded. B) 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. C) The exercise of NSOs does not create taxable income. D) 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) 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. 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. LO 1.d

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) $16 B) $8 C) $6 D) $12

C) $6 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. LO 1.c

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

D) the right to determine the par value of the stock. 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. LO 1.b

Which of the following statements best describes cumulative preferred stock? A) Owners are allowed to vote for directors using the cumulative voting procedures. 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 lose any claim to dividends that are not paid in any one year. D) 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. 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. LO 1.c

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) Unregistered stock acquired by a nonaffiliate under an investment letter C) Unregistered stock acquired by a corporate affiliate in a stock option program D) Stock acquired by a corporate affiliate in a private placement 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. LO 1.e

A) Stock acquired on the NYSE by a corporate affiliate 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. LO 1.e

All of the following statements regarding incentive stock options (ISOs) are correct except A) 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 B) if the holding period is satisfied, the gain upon the sale of ISO shares will be a long-term capital gain C) upon the exercise of an ISO, income for AMT purposes is created D) the exercise of ISOs does not create taxable income

A) 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 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. LO 1.d

Which of the following is not a characteristic of American depositary receipts (ADRs)? A) ADRs are denominated and pay dividends in U.S. dollars, not foreign currencies, thus saving the investor transaction costs with respect to converting currencies. B) Dividends are declared in the foreign currency, so exchange rate, or currency, risk is completely eliminated. C) ADR holders may surrender ADRs in exchange for receiving the shares of the non-U.S. company. D) Because ADRs are traded on the exchanges, they are relatively liquid and marketable investments.

B) Dividends are declared in the foreign currency, so exchange rate, or currency, risk is completely eliminated. ADRs are receipts issued by a U.S. bank for shares of a foreign company purchased and held by a foreign branch of the bank. Dividends are declared in the local currency, so exchange rate, or currency, risk is not completely eliminated. They are generally traded on one of the major exchanges ensuring liquidity. They are an alternative to investing directly in foreign companies or foreign mutual funds. If the investor desires the foreign shares, the ADR may be surrendered and the exchange made. LO 1.f

One of the rights of being a common stockholder is the ability to vote on important corporate matters, such as the election of members to the board of directors. The date that determines which shareholders are eligible to vote is A) the ex-dividend date. B) the last day of the company's fiscal year. C) the record date. D) the election date.

C) the record date. The record date is a date announced by the company as the official date you must be an owner on the company's records in order to participate in the annual meeting and corporate election. A fact not tested is there is no standard regarding how far in advance of the voting date this should be other than it must be at least the normal settlement period, currently two business days. LO 1.b

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) $16 B) $8 C) $6 D) $12

C) $6 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. LO 1.c

All of the following statements regarding incentive stock options (ISOs) are correct except A) the exercise of ISOs does not create taxable income B) upon the exercise of an ISO, income for AMT purposes is created C) 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 D) if the holding period is satisfied, the gain upon the sale of ISO shares will be a long-term capital gain

C) 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 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. LO 1.d

One of the features of convertible preferred stock is that A) the dividend is paid ahead of all other securities. B) the holder is able to select the conversion price. C) the owner has the opportunity to participate in the growth of the company. D) the owner has the opportunity to convert the stock into the issuer's bonds.

C) the owner has the opportunity to participate in the growth of the company. Any convertible security, preferred stock, or debenture is convertible into the issuer's common stock. As a result, if the business is successful, the common stock's price will rise to the point where conversion is a wise idea. Although the investor can generally select when to convert, the conversion price or ratio is set at the time of issuance. Interest on debt securities is paid before the dividends on any stock. When it comes to preferred stock, there is frequently a pecking order, such as a prior lien preferred or first preference preferred that would come ahead of the other preferred shares. LO 1.c

A) Stock acquired on the NYSE by a corporate affiliate B) Unregistered stock acquired by a nonaffiliate under an investment letter C) Unregistered stock acquired by a corporate affiliate in a stock option program D) Stock acquired by a corporate affiliate in a private placement 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. LO 1.e

D) at the time of the grant, the recipient of the grant of the ISO has no income tax consequences while the recipient of the NSO treats the bargain element as compensation. Whether the grant is of an ISO (qualified) or an NSO (nonqualified), there are no tax consequences to the recipient at the time of the grant. It is only after exercise (NSO) and sale after exercise (ISO) that the recipient of the grant has tax consequences. Each of the other choices represents a difference. ISOs can only be granted to employees, while the NSO can also be granted to members of the board of directors and even to vendors. With an ISO, capital gain (loss) treatment is available upon the sale of the stock if the recipient holds the stock purchased through exercise at least one year from the date of exercise and at least two years from the date of the grant. With an NSO, the recipient can only have ordinary income (loss) based on the difference between the exercise price and the market value when the option is exercised. Finally, if the recipient of an ISO does not exercise the option within 10 years of the grant, it is treated as an NSO for tax purposes. LO 1.d

One way in which incentive stock options (ISOs) differ from nonqualified stock options (NQSOs) is that A) gains on an ISO are always short term, while those on an NQSO are long term. 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) the bargain element of the ISO is an AMT preference item.

D) the bargain element of the ISO is an AMT preference item. 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. LO 1.d