Series 7 Chapter 1: Equity Securities

ABC Corporation, whose common stock is trading at $32, has issued $40 million of 8-1/8% debentures due 10-1-14. Each bond issued with a $1,000 PAR value has a warrant attached enabling the holder to buy 4 shares of ABC common at $40 per share. If all of the warrants are exercised, ABC Corporation will receive: A) $12.8 million. B) $6.4 million. C) $20 million. D) $10 million.

Your answer, $12.8 million., was incorrect. The correct answer was: $6.4 million. There are a total of 40,000 warrants outstanding ($40 million of debentures / $1,000 par value per bond). Each warrant entitles the holder to buy 4 shares of common stock. Therefore, if all warrants are exercised, holders will be purchasing 160,000 shares (4 × 40,000) at $40 per share. 160,000 × $40 = $6.4 million.

For reporting purposes, an order to sell 25 shares of an OTC equity security priced at $230 per share is: A) 25 round lots. B) 1 odd lot. C) 25 odd lots. D) 1 round lot.

Your answer, 1 odd lot., was incorrect. The correct answer was: 25 round lots. For OTC equity securities trading at or above $175 per share, 1 share is considered to be a round lot unit of trading. Therefore all last sale information will be disseminated for any transaction of one share or more.

Gargantuan Computers, Inc. (GCI) conducts a rights offering to its current shareholders at $50 per share, plus 1 right. If the current market price of GCI is $70, what is the value of one right before the stock trades ex-rights? A) 15 B) 5 C) 10 D) 3

Your answer, 15, was incorrect. The correct answer was: 10 The stock is trading cum rights (before the ex-date). The formula to calculate the value of one right before the ex-date is follows: CMV − subscription price / Number of rights to purchase 1 share + 1. Therefore one right is valued at $10, computed as ($70 − $50) / 2 = $10.

Smith and Co., Inc. has 1 million shares of common stock outstanding and plans to sell 200,000 new shares via a rights offering. Joe Wilson, a common stockholder, owns 200 shares of the company. How many rights will he receive in the mail, and how many rights will it take to purchase one of the new shares? A) 100 rights, 5 per share. B) 100 rights, 20 per share. C) 200 rights, 5 per share. D) 200 rights, 20 per share.

Your answer, 200 rights, 20 per share., was incorrect. The correct answer was: 200 rights, 5 per share. Stockholders receive one right per share owned. Hence, Joe receives 200 rights. The purpose is to maintain shareholders' proportionate interest in the company. Since the number of shares outstanding will increase by 20%, Joe needs to purchase 40 new shares (200 / 40 = 5 rights per share).

Which of the following is a function of a registrar? A) Transferring shares into the name of a new owner. B) Accounting for the number of shares outstanding. C) Canceling old shares. D) Recording the names of stockholders on the corporation's books.

Your answer, Accounting for the number of shares outstanding., was correct!. The registrar's function is to ensure that the number of shares outstanding does not exceed the number accounted for on the corporation's books. The transfer agent records the names of stockholders on the corporation's books, cancels old shares, and transfers shares into a new owner's name.

Which of the following securities typically carries the highest dividend rate? A) Participating preferred. B) Straight preferred. C) Convertible preferred. D) Callable preferred.

Your answer, Callable preferred., was correct!. Straight preferred is the benchmark rate. As the name suggests, there are no conversion or participating features. Compared to straight preferred, both convertible and participating preferred tend to carry lower dividend rates, as the investor has been given something extra-the right to convert into common shares at a fixed price or the right to earn more than the stated rate if the issuer has a good year and the board of directors elects to make an additional dividend payment. Callable preferred allows the issuer to call the securities away from the investor. From an investor's point of view, this is not an incentive. Therefore, callable preferred tends to pay higher rates.

If a corporation attaches warrants to a new issue of debt securities, which of the following would be a resulting benefit to the corporation? A) Increase in earnings per share. B) Dilution of shareholders' equity. C) Reduction of the debt securities' interest rate. D) Reduction of the number of shares outstanding.

Your answer, Dilution of shareholders' equity., was incorrect. The correct answer was: Reduction of the debt securities' interest rate. Usually, a warrant is issued along with a debt instrument, an enhancement that allows the issuer to offer a slightly lower rate of interest.

A customer is considering adding a real estate investment trust (REIT) to their portfolio. They list all of the following as "plusses" or advantages. You correct your customer and point out that one of them is not an advantage of investing in REITs. Which of the following is NOT an advantage of investing in REITs? A) Dividend treatment B) Being able to divest of the shares easily C) Having a professionally managed portfolio of commercial real estate assets D) Using real estate as a potential hedge against the movement of other equity securities the customer owns

Your answer, Dividend treatment, was correct!. Of those listed, only dividend treatment can be identified as not being an advantage. While the expectation of receiving dividends is inherently good, dividends paid by REITs to their shareholders are not recognized as qualified and are, therefore, taxable to the investor at their full ordinary income tax rate. The shares are traded on exchanges or OTC and considered liquid, and having professionally managed assets should be a plus. While real estate valuation and price movements are subject to many forces, historically, real estate has provided some hedge against the movements of other equity securities.

Which of the following statements regarding real estate investment trusts are TRUE? Hybrid REITs invest in both commercial property and residential property. Some REITs hold no real property but hold mortgages on commercial property instead. All dividend disbursements made by REITs will be recognized as qualified dividends by the IRS. Dividends are taxed at the investor's ordinary income tax rate. A) I and III B) II and IV C) II and III D) I and IV

Your answer, I and III, was incorrect. The correct answer was: II and IV Equity REITs can hold residential and commercial property, mortgage REITs hold mortgages on property, and hybrid REITs do both. Dividend disbursements made by the trusts are not recognized as qualified dividends and, therefore, will be taxable to the investor at their ordinary income tax rate.

A company may pay dividends in which of the following forms? Preemptive rights. Cash. Its own stock. Its own bonds. A) I and III. B) II and IV. C) I and IV. D) II and III.

Your answer, I and III., was incorrect. The correct answer was: II and III. A company may pay a dividend in stock of another company, cash, its own stock, or its own product. Preemptive rights are used in subsequent primary offerings, and bonds trade separately.

The ex-dividend date is the: date on and after which the buyer is entitled to the dividend. date on and after which the seller is entitled to the dividend. second business day before the record date. second business day after the record date. A) I and II. B) II and IV. C) I and IV. D) II and III.

Your answer, II and III., was correct!. Stock sold on the ex-dividend date entitles the seller to the dividend; ex-date is two business days before the record date.

Which of the following statements regarding preferred stock is NOT true? A) The dividend is fixed except in the case of adjustable preferred. B) Unlike debt, preferred stock has no set maturity date. C) Voting rights of preferred shareholders take precedence over those of common shareholders. D) Because there is no set maturity value or redemption date, the holder of preferred stock has to sell his shares in the open market to close out his position.

Your answer, Voting rights of preferred shareholders take precedence over those of common shareholders., was correct!. Preferred shareholders do not generally have voting rights. Voting rights are characteristic of common stock, not preferred. Preferred stock is unlike debt securities in that it has no set maturity date. It is true that the dividend on a preferred stock is fixed, except in the case of an adjustable preferred where the dividend can be tied to a market interest rate and readjusted. The holder of a preferred has to sell the shares in the open market to close out his position.

Which of the following securities CANNOT pay a dividend? A) Warrant. B) ADR. C) Convertible preferred stock. D) Class B common stock.

Your answer, Warrant., was correct!. Warrants represent long-term options to buy stock at a fixed price, and, like options, cannot pay dividends.

REITs can distribute all of the following to their shareholders EXCEPT: A) cash dividends. B) capital losses. C) stock dividends. D) capital gains.

Your answer, capital losses., was correct!. REITs can distribute their income to shareholders but not their losses. Under subchapter M of the Internal Revenue Code, they must distribute at least 90% of their income to shareholders in the form of cash dividends.

In a portfolio containing common stock, preferred stock, convertible preferred stock, and ADRs, changes in interest rates would most likely affect the market price of the: A) ADRs. B) common stock. C) convertible preferred stock. D) preferred stock.

Your answer, convertible preferred stock., was incorrect. The correct answer was: preferred stock. Preferred stock has the closest characteristics to bonds and would be most affected by a change in interest rates. Convertible preferred stock would also be affected by price changes in the underlying common stock.

A new bond issue will include warrants to: A) increase the spread to the underwriter. B) increase the attractiveness of the issue to the public. C) increase the capital raised by the issuer through the bond offering. D) increase the price of the issue to the public.

Your answer, increase the attractiveness of the issue to the public., was correct!. By including warrants with debt issues, issuers increase the marketability of bonds. The warrants offer a long-term opportunity to buy the underlying stock at a fixed price. In addition to increasing the marketability of the issue, the issuer can offer the bonds with a lower coupon rate and, as a result, reduce fixed costs.

The record date: A) indicates when the public offering of new issues can be made legally. B) is set by the issuing corporation to determine which stockholders will receive a declared dividend. C) is set by the issuing corporation as the mailing date for distribution of cash dividends. D) is fixed by the SEC to determine which investors own stock.

Your answer, is fixed by the SEC to determine which investors own stock., was incorrect. The correct answer was: is set by the issuing corporation to determine which stockholders will receive a declared dividend. The record date is set by the corporation, at which time a list of stockholders who will receive a dividend is compiled.

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

Your answer, issue fixed-rate securities at a yield lower than usual., was incorrect. The correct answer was: replace a high, 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 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.

When compared to statutory voting, cumulative voting gives an advantage to: A) participating preferred stockholders. B) majority stockholders. C) minority stockholders. D) management rather than the board of directors.

Your answer, minority stockholders., was correct!. Cumulative voting allows shareholders to aggregate their votes and cast them as they please. For example, they could cast all of their votes for a single candidate. Cumulative voting makes it easier for a minority group of shareholders to gain representation on the board.

A corporation must have stockholder approval to: A) declare a 15% stock dividend. B) issue convertible bonds. C) repurchase 100,000 shares of stock for its treasury. D) declare a cash dividend.

Your answer, repurchase 100,000 shares of stock for its treasury., was incorrect. The correct answer was: issue convertible bonds. Stockholders are entitled to vote on the issuance of additional securities that would dilute shareholders' equity (the shareholder's proportionate interest). Conversion of the bonds would cause more shares to be outstanding, thus reducing the proportionate interest of current stockholders. Decisions that are made by the board of directors and do not require a stockholder vote include the repurchase of stock for its treasury, declaration of a stock dividend, and declaration of a cash dividend.

Shareholder approval is required for all of the following corporate events EXCEPT: A) the acceptance of a tender offer from a non-affiliated company. B) stock splits. C) dividends. D) the issuance of convertible bonds.

Your answer, stock splits., was incorrect. The correct answer was: dividends. Shareholder approval is not required for the payment of dividends, but is normally required for actions that increase (or potentially increase) the number of shares outstanding, such as stock splits and the issuance of convertible bonds. A corporation's acceptance of a tender offer requires shareholder approval.

Holders of common shares may generally vote on: A) whether an administrative assistant should be promoted to management. B) whether a cash dividend is to be declared. C) which member of the board of directors should be chairman. D) whether the company should issue additional preferred stock.

Your answer, which member of the board of directors should be chairman., was incorrect. The correct answer was: whether the company should issue additional preferred stock. Common shareholders must vote to approve the issuance of additional preferred stock because additional preferred shares dilutes the common shares' residual assets under a liquidation. Common shareholders do not vote to declare dividends. Board members select the chairman of the board. Shareholders do not get involved in the daily operational activity of the corporation.