Series 65 Unit 1 Equity Securities

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

Answer: B A common stock's dividend payment and amount are determined by the company's board of directors.

All of the following are advantages of investing in American Depositary Receipts (ADRs) EXCEPT: A) transactions are done in U.S. currency. B) currency risk is virtually eliminated. C) ADRs fall under the oversight of the SEC. D) dividends are received in U.S. currency.

Answer: B ADRs carry currency risk because distributions on ADRs must be converted from foreign currency to U.S. dollars on the date of distribution. In addition, the trading price of the ADR is affected by foreign currency fluctuation.

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

Answer: B Common and preferred stockholders have equity, or ownership positions. Bondholders (mortgage or otherwise) are creditors, not owners.

Which of the following securities is considered the most junior? A) Prior lien preferred stock. B) Common stock. C) Mortgage bond. D) Debenture.

Answer: B In the event of a company's bankruptcy, common stock owners have the lowest priority in claims against corporate earnings and assets. This identifies common stock as the most junior security.

Rank the following from most suitable to least suitable for a client whose primary objective is income: I. Cumulative preferred stock II. Cyclical common stock III. Large-cap stock IV. Warrant A) I, III, II, IV B) I, II, III, IV C) III, I, IV, II D) III, II, IV, I

Answer: A For a client seeking income, preferred stock, especially one that is cumulative, would likely be the most suitable of the choices given. That would be followed by a large-cap stock, sometimes referred to as a blue-chip stock. Cyclical stocks have income that varies with the economic cycles so their dividends, if any, tend to fluctuate and warrants never provide any income.

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. A) II and III. B) II and IV. C) I and III. D) I and IV.

Answer: C ADRs are issued by large domestic commercial banks to facilitate U.S. investors who want to trade in foreign securities.

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

Answer: C American Depositary Receipts (ADRs) make trading in foreign securities easier in U.S. markets for U.S. investors.

An investor may expect to receive dividends from a(n): A) put option. B) call option. C) warrant. D) ADR.

Answer: D An American Depositary Receipt (ADR) represents ownership in a foreign corporation, and dividends declared by the corporation are paid to the ADR owner. The currency conversion is performed by the issuing domestic bank. Options and warrants do not grant the holder the right to receive dividends on the underlying stock.

An investment in which of the following would expose the investor to the greatest capital risk? A) Preferred stock. B) Mortgage bonds. C) Common stock. D) Debentures.

Answer: C Capital risk is the risk of losing capital. Of the choices given, the greatest risk of losing capital is the common stock, as common shareholders come last in liquidation under bankruptcy proceedings.

All of the following pay dividends EXCEPT: A) warrants. B) common stock. C) preferred stock. D) convertible preferred stock.

Answer: A Warrants do not pay dividends; the other instruments listed pay dividends when declared by the board of directors.

An investor holding which of the following equity securities would NOT expect to have preemptive rights? A) Control stock. B) Preferred stock. C) Common stock. D) Common stock acquired in a private placement.

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

Answer: B 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.

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) $15.00 B) $25.00 C) $10.00 D) $5.00

Answer: C 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.

ADR owners have all the following rights EXCEPT: A) the right to receive dividends in U.S. dollars. B) the right to receive the underlying foreign security. C) the right to sell the ADR in the foreign market. D) the right to sell in the secondary market.

Answer: C The purpose of the ADR is to facilitate trading in U.S. markets. The ADR can only be traded here. If the owner exercises the right to obtain the actual foreign security, it may be sold overseas.

All of the following are characteristics of a rights offering EXCEPT: A) the subscription period is up to 2 years. B) the subscription price is below the current market value. C) it is issued to current stockholders. D) the rights are marketable.

Answer: A Rights offerings are usually very short-lived (30 to 45 days).

Which of the following statements regarding rights is TRUE? A) Both common and preferred stockholders have the right to subscribe to a rights offering. B) Neither common nor 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) Common stockholders do not have the right to subscribe to a rights offering.

Answer: C Preferred stockholders have a preference as to liquidation and distribution of dividends, but they have no right to maintain a percentage of ownership.

Programs allowing for the direct pass-through of losses and income to investors include all of the following EXCEPT: A) REITs. B) S corporations. C) oil and gas drilling direct participation programs. D) new construction real estate direct participation programs.

Answer: A REITs allow for the direct pass-through of income but not losses. The other choices are forms of business which allow for pass-through of income and losses.

Which of the following statements regarding ADRs are TRUE? I. The securities are vehicles used to facilitate U.S. trading of foreign securities. II. Dividends are received in the foreign currency. III. Holders have foreign currency risk. IV. 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.

Answer: B 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.

By investing in a REIT, you are provided all of the following EXCEPT: A) diversification of real estate investment capital. B) pass-through tax treatment of income. C) pass-through tax treatment of operating losses. D) ownership of real property without management responsibilities.

Answer: C REITs cannot pass through losses to investors. It is important to remember that they are not DPPs.

Mr. Brown has received preemptive rights from one of the stocks held in his portfolio. Which of the following is NOT an alternative regarding these stock rights? A) Selling at the market. B) Exercising. C) Redeeming them from the issuer for cash. D) Giving the rights to his son.

Answer: C Rights are not redeemable by the issuer. They may be sold in the secondary market or be given to someone else to exercise. If exercised, rights are exchanged for an appropriate number of shares of the underlying common stock.

Which of the following are TRUE of a REIT? I. It can qualify for special tax treatment under Subchapter M of the Internal Revenue Code if it distributes at least 90% of its taxable income. II. It may loan money for commercial construction projects. III. It generates income by the spread between rental income, the combined mortgage interest, and operating expenses of the property. IV. It is only suitable for an investor who is in a 28% or higher tax bracket, who has a net worth in excess of $200,000, or who is able to benefit from the flow through of losses. A) I, II and IV B) I and III C) II and III D) I, II and III

Answer: D A real estate investment trust (REIT) is an investment that makes direct investments in real estate, generating its income from renting the property (e.g., apartments, shopping malls) to lessees. Alternatively, it can make mortgage loans and generate income from them. Depending on its distribution of income, it may qualify for the same type of special tax treatment as a regulated investment company. REITS are not flow-through vehicles as are DPPs.

All of the following are redeemable securities EXCEPT: A) mutual funds. B) unit investment trusts. C) variable annuities. D) REITs.

Answer: D A redeemable security has no secondary market. To sell (redeem) a redeemable security, the investor must go back to the issuer or its agent. REITs trade in the secondary markets either on exchanges or OTC.

When analyzing a preferred stock, an investment adviser would give the most credence to: A) earnings per share. B) book value per share. C) the ability of the company to pay the stated dividend. D) the company's short-term debt obligations.

Answer: C Preferred stock is purchased primarily as an income security based on its fixed dividend. Therefore, any analysis would tend to place the ability of the issuer to meet that dividend paramount. Earnings per share and book value per share are computations relevant to common stock only.

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 one year from the date of grant or two years from the date of exercise. C) the exercise of ISOs does not create taxable income. D) upon the exercise of an ISO, income for AMT purposes is created.

Answer: B The favorable tax treatment is lost if the shares acquired through the ISO exercise are sold before one year from the date of exercise or two 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.

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 2 previous years. How much must the company pay the customer per share before it may pay dividends to the common stockholders? A) $8.00 B) $16.00 C) $24.00 D) $0.00

Answer: C 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.

In which type of real estate investment does an investor have a reasonable expectation of receiving periodic distributions in the form of dividends? A) Undeveloped land. B) Rental real estate. C) The purchase of a primary residence. D) A real estate investment trust (REIT).

Answer: D A REIT is an indirect form of ownership of real estate. For tax purposes, at least 90% of the REIT's investment income is distributed to investors in the form of a taxable dividend. Unlike DPPs, there is no flow-through of losses.

A change in interest rates will have the most immediate impact upon: A) preferred stock. B) common stock. C) ETFs. D) REITs.

Answer: A Interest rate risk is predominately found with fixed income investments. Preferred stock with its fixed dividend, will be impacted by changes in the cost of money. Of course, you might challenge this answer claiming that if the ETF was based on a long-term bond index, that could certainly be the correct choice. But, unless specified, assume all ETFs are equity based.

All of the following are true of REITs EXCEPT: A) they must pass along losses to shareholders. B) they must invest at least 75% of their assets in real estate-related activities. C) they must distribute at least 90% of their net investment income in order to qualify for the special tax treatment afforded under Subchapter M of the IRC. D) they must be organized as trusts.

Answer: A REITs engage in real estate activities and can qualify for favorable tax treatment if they pass through at least 90% of their net investment income to their shareholders. While they can pass through income, they cannot pass through any losses; they are not DPPs.

Reasons why a corporation might issue a convertible preferred stock would include: A) giving those shareholders an opportunity to participate in the future success of the company. B) giving those shareholders the ability to convert into the issuer's bonds. C) tax savings to the issuer. D) a lower cost to the issuer than would be incurred by the issuance of convertible bonds.

Answer: A The benefit of any convertible security, bond or preferred stock, is that the ability to convert into the issuer's common stock allows those investors to participate in the potential future growth of the company. One does not convert into a bond and, because preferred dividends are an after-tax outlay, there are no tax savings as there would be with bond interest. Since stock is lower in claim than bonds, the dividend rate would have to be higher than the interest rate on bonds.

Which of the following are characteristics of a REIT? I. It is traded on an exchange or over the counter. II. It is professionally managed. III. It passes through both gains and losses to investors. IV. It is a type of limited partnership. A) II and III B) III and IV C) I and II D) I and IV

Answer: C A REIT shares some features with a limited partnership, but it is a different type of business entity. REITs are traded on exchanges and OTC and are professionally managed. Both REITs and limited partnerships provide pass-through of gains to investors, but REITs do not provide pass-through of losses. Please note: We recognize that, over the past few years, there has been an enormous growth in non-traded REITs (exactly what that says - they don't trade; there is no liquidity). However, we have received no feedback about that issue and, unless something in the question refers to a non-traded REIT, assume that all REITs are publicly traded either on the stock exchanges or OTC.

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

Answer: C 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.

Which of the following statements about corporate dividends are TRUE? I. Corporations are contractually obligated to pay dividends to their shareholders each year. II. Dividends represent a pro rata distribution of corporate profits to shareholders. III. Dividends may be paid in cash, property, or stock. A) I and III. B) I, II and III. C) II and III. D) I and II.

Answer: C 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.

One of the benefits of receiving incentive stock options from your employer rather than non-qualified stock options is: A) that more shares are generally available through ISOs than NSOs. B) it is not necessary to hold ISOs as long as NSOs. C) the opportunity to receive long-term capital gains tax treatment. D) the exercise price is usually below the current market price.

Answer: C NSOs are treated as ordinary income when exercised while ISOs can result in long-term capital gains if certain holding periods are met.

Investing in emerging market stocks primarily exposes your client to which of the following risks? I. Currency. II. Inflation. III. Liquidity. IV. Political. A) I and IV. B) I, III and IV. C) II and III. D) I, II, III and IV.

Answer: D Any investment in a foreign stock incurs currency risk. The nature of emerging markets is such that there is a higher political risk as well as potential limited liquidity. It is not unusual for emerging markets to have a bout of raging inflation from time to time.

Which of the following statements regarding foreign investing is (are) TRUE? I. Foreign financial markets are more efficient than the U.S. market. II. Most foreign investment entails the systematic risk of foreign exchange. III. Adding foreign-issued securities to a portfolio provides the greatest diversification when the foreign stock market has a 1.0 correlation relative to the U.S. market. IV. Foreign securities markets are more highly regulated than the U.S. market. A) II only. B) I and II. C) II and IV. D) I, II, III and IV.

Answer: A Foreign markets entail the systematic risk of foreign exchange. Most foreign markets are not more efficient than the U.S. market. The U.S. market is among the most highly regulated market in the world. A 1.0 correlation offers no diversification.

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

Answer: D 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 decline. Callable preferred allows the company to take advantage of reduced interest rates by calling in high-rate issues and replacing them with lower ones. The marketplace requires that the company pay a higher dividend yield compared to one that is not callable. This compensates the investor for taking the risk of a future call.

Bail Bonds, Inc., might issue warrants in connection with a bond issue for which of the following reasons? I. As an inducement to make the bonds more marketable. II. To lower their interest cost on the issue. III. To increase the marketability of their common stock. IV. To increase the number of common shares outstanding. A) I and II. B) I only. C) I and IV. D) I, II, III and IV.

Answer: A Warrants permit the purchase of common stock of the issuer at a fixed price. A bond with warrants attached has more value than a straight bond and is more attractive (marketable) to investors. Attaching warrants to a bond issue usually permits the bonds to be issued with a lower interest rate.

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

Answer: D 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.

An employee is offered a non-qualified 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) is taxed on $10 per share as if it were salary. B) is taxed on $20 per share as if it were salary. C) is taxed on $30 per share as if it were salary. D) has a capital gain of $10 per share.

Answer: A In the case of NSOs, the difference between the exercise (or strike) price and the current market value is considered salary to the employee.

If a client who seeks diversification through real estate is concerned about illiquidity associated with investing in real estate, which of the following investments is most suitable? A) Real estate investment trust. B) Interest in a real estate limited partnership. C) Direct investment in a shopping center renting retail space to a broad variety of stores. D) Privately placed investment.

Answer: A Real estate investment trusts (REITs) are best suited to the client because they are market-traded securities that provide an investor with a liquid market in which to invest in real estate.

Which of the following statements regarding nonqualified (nonstatutory) stock options (NSOs) are CORRECT? I. There is one specified manner in which NSO stock option plans may be designed. II. There are no nondiscrimination rules to apply when establishing one of these plans. III. This is one type of stock option in which participating employees can actually suffer a loss. IV. When the employee purchases shares, the employer must withhold and pay federal income taxes with respect to the "bargain element" of the shares purchased. A) I, II and III. B) II and IV. C) I and II. D) III and IV.

Answer: B One of the benefits of NSOs is that the employer may discriminate when it comes to offering the options. One of the disadvantages is that the "profit" as it were when the shares are purchased is considered salary income with the attendant payroll and income taxes.

As interest rates fall, prices of straight preferred stock will: A) fall. B) remain unaffected. C) become volatile. D) rise.

Answer: D Preferred stock is interest rate sensitive. As rates fall, prices of preferred stocks tend to rise, and vice versa.

The Board of Directors of DDC omitted dividends in 2010 on their $100 par 6% noncumulative preferred stock. In 2011, a $2 preferred dividend was paid. For DDC, 2012 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 2012 in order to pay a common dividend? A) $6.00 B) $8.00 C) $12.00 D) $16.00

Answer: A 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.

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) convert the stock into the issuer's bonds.

Answer: C 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.

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

Answer: D 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. 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 statements about preemptive rights are TRUE? I. Preemptive rights give shareholders the right to purchase shares in new stock issues in direct proportion to the number of shares they already own. II. Preemptive rights allow shareholders to buy as many new shares as they want at any time. III. Preemptive rights allow shareholders to maintain their proportionate share of ownership in the corporation. A) II and III. B) I, II and III. C) I and III. D) I and II.

Answer: C Preemptive rights give shareholders the right to purchase, in direct proportion to the number of shares they already own, shares in new issues of stock before they are offered to the general public. This allows current shareholders to maintain their proportionate share of ownership in the corporation.

Which of the following statements regarding nonqualified stock options (NSOs) is(are) CORRECT? I. The exercise of NSOs does not create taxable income. II. 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. III. Unlike ISOs, NSOs are publicly traded​. A) II only B) I only C) I and III D) II and III

Answer: A 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 are publicly traded.​

Which of the following is NOT a characteristic of a real estate investment trust (REIT)? A) Pooling of capital to purchase properties or mortgage loans B) Potential dividends from investment income or capital gains distributions C) Relatively low marketability D) Shares are traded on exchanges much like the stocks of other companies

Answer: C A real estate investment trust (REIT) is a company that pools its capital to purchase properties and/or mortgage loans. Investors buy REIT shares and, in turn, receive dividends from investment income or capital gains distributions. REIT shares are traded on exchanges much like the stocks of other companies. This provides relatively high marketability, especially compared to most other types of real estate investments. Please note: We recognize that, over the past few years, there has been an enormous growth in non-traded REITs (exactly what that says - they don't trade; there is limited or no liquidity). However, we have received no feedback about that issue and, unless something in the question refers to a non-traded REIT, assume that all REITs are publicly traded either on the stock exchanges or OTC.

All of the following characteristics are advantages of a REIT EXCEPT A) liquidity B) diversification C) professional management D) tax deferral

Answer: D A REIT is a professionally managed company that invests in a diversified portfolio of real estate holdings. REITs are traded on exchanges and OTC, which provides liquidity. The IRS does not permit tax deferrals on REIT investments. Please note: We recognize that, over the past few years, there has been an enormous growth in non-traded REITs (exactly what that says - they don't trade; there is no liquidity). However, we have received no feedback about that issue and, unless something in the question refers to a non-traded REIT, assume that all REITs are publicly traded either on the stock exchanges or OTC.

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) convertible preferred stock D) adjustable rate preferred stock

Answer: A 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 it usually tied to changes in interest rates, the price of this stock remains stable in the face of rising or falling rates.

Brian is an employee of Toeva Manufacturing Co, (TMC) listed on the AMEX. TMC offers Brian incentive stock options on December 16, 2011 to purchase 100 shares of the company's stock at $20 per share. Brian exercises the option on December 22, 2012 when TMC is trading on the AMEX at $30. Then, on December 28, 2013, Brian sells the stock for $40 per share. Brian: A) must report $1,000 as salary. B) has a long-term capital gain of $2,000. C) must report $2,000 as salary. D) must report $1,000 as salary and has a long-term capital gain of $1,000.

Answer: B In order for an ISO to qualify for favorable tax treatment, the shares acquired cannot be sold sooner than one year after exercise as long as that is at least two years after granting of the option. The shares were sold more than one year after exercise and the total time period exceeded two years.

A member of the investment banking department of ABC securities is explaining some of the advantages and disadvantages of rights and warrants to the board of directors of XYZ Corporation. Which of the following statements could he make? I. The exercise prices of stock rights are usually below the current market price of the underlying security at time of issue. II. The exercise prices of warrants are usually above the current market price of the underlying security at time of issue. III. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. IV. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer. A) I and II. B) I, II and III. C) I, II, III and IV. D) I only.

Answer: C All are true statements. The exercise prices of stock rights are usually below the current market price of the underlying security at time of issue. The exercise prices of warrants are usually above the current market price of the underlying security at time of issue. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer.

Your customer owns $100 par 5-½% callable convertible preferred stock convertible into 4 shares of common stock at $25. What should she be advised to do if the board of directors were to call all the preferred at 106 when the common stock is trading at $25.50? A) Hold the preferred stock to continue the 5-½% yield. B) Present the preferred stock for the call because the call price is $4 above the parity price. C) Convert her preferred stock into common stock because it is selling above parity. D) Place irrevocable instructions to convert the preferred stock into common stock and sell short the common stock immediately.

Answer: B If the preferred stock is called, the client will receive $106. Tendering the preferred stock will provide the highest value. The value of converting the preferred stock into 4 shares of common is worth $102 (4 × $25.50 = $102), which is less than the call value of $106. The dividends will cease on the call date if the preferred stock is held beyond the call date.

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 receive an extra dividend along with common shareholders, in addition to the preferred dividend. C) Owners have a continuing claim to their dividends, and all arrears must be paid before any dividends can be paid on common stock. D) Owners lose any claim to dividends that are not paid in any one year.

Answer: C 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.

Which of the following statements regarding warrants is TRUE? A) Warrants are often issued with other securities to make the offering more attractive. B) Warrants give the holder a perpetual interest in the issuer's stock. C) Warrants' terms are generally shorter than rights' terms. D) Warrants are safer than corporate bonds.

Answer: A Warrants are generally issued with bond offerings to make the bonds more attractive. Warrants are long-term options to buy stock, and because they are equity securities, warrants, as investments, are considered less safe than bonds.

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

Answer: A 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.

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

Answer: A The residual right of common shareholders refers to their position in the event of bankruptcy.

All of the following are advantages of investing in a REIT EXCEPT: A) flow-through of income. B) limited investment risk. C) limited management responsibility. D) flow-through of losses.

Answer: D REITs cannot pass through operating losses but can distribute net operating gains without paying corporate income tax. Investment risk is limited to what the investor pays for the investment. The investor has no property management responsibilities.

GHI currently has earnings of $4 and pays a $0.50 quarterly dividend. If GHI's market price is $40, the current yield is A) 1.25% B) 10% C) 15% D) 5%

Answer: D The quarterly dividend is $0.50, so the annual dividend is $2; $2 ÷ $40 market price = 5% current yield.

ADRs are used to facilitate the: A) domestic trading of foreign securities. B) foreign trading of domestic securities. C) foreign trading of U.S. government securities. D) domestic trading of U.S. government securities.

Answer: A An ADR is a negotiable security that represents an ownership interest in a non-U.S. company. Because they trade in the U.S. marketplace, ADRs allow investors convenient access to foreign securities.

A corporation with a 7% $100 par cumulative preferred paid $5 to preferred stockholders last year. Before the company can pay common dividends, how much must it pay each preferred share outstanding? A) $7.00 B) $15.00 C) $9.00 D) $3.00

Answer: C A cumulative preferred must pay all unpaid cumulative preferred dividend amounts prior to payment to common stockholders. The company had only paid $5 of the $7 due last year, so the $2 in arrears must be paid. The preferred shareholders will receive $9 ($7 + $2 = $9).

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) pre-emptive rights. B) voting trust certificates. C) subordinated debentures. D) employee stock options.

Answer: D 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.

Which of the following statements accurately describes the doctrine of limited liability? A) A shareholder of a corporation has some personal liability for the corporation's debts. B) A partner is not personally liable for the debts of the partnership. C) The owner of a sole proprietorship is not personally liable for the proprietorship's debts. D) A shareholder of a corporation is not personally liable for the corporation's debts.

Answer: D The owners of certain kinds of businesses such as sole proprietorships and partnerships have unlimited liability for the business' debts. The doctrine of limited liability means, however, that the owners of a corporation (the shareholders) are not personally liable for the corporation's debts.