Equity Securities - SIE (Chapter 1)

Important Points about Rights and Warrants

1. Rights and warrants may trade as independent securities in the secondary market. 2. Warrants typically remain outstanding longer than rights. 3. Warrants are generally not issued with intrinsic value, meaning they are issued with an exercise price above the current market value of the stock. They are not valuable until the stock's price increases. 4. The market value of a warrant is connected to the value of the underlying stock.

Diversification

A risk-management technique that mixes a wide variety of investments within a portfolio. Positive performance of some investments will neutralize the negative performance of others.

Short Sale

A transaction in which an investor, believing the price will decline, sells borrowed shares in the market, hoping to buy back and replaced the shares at a lower price than what they were initially sold for.

Rights

Allow shareholders to buy shares to maintain their proportionate ownership in the company if the company issues additional shares.

Cumulative Voting

Allows the shareholder to pool votes together and then allocate them as desired. Ex. The shareholder has a total of 20 votes for the 10 shares that are held. The shareholder can cast 20 votes for one candidate, 15 for one candidate and five for another, or any other allocation preferred by the investor.

Statutory Voting

Allows the shareholder to vote one time per share for each seat on the board of directors. Ex. If an investor owns 10 common shares and two board seats are to be filled, the investor has up to 10 votes to cast for each of two directors seeking election to the board.

Stock Split

An artificial adjustment of a company's stock price and number of shares with no actual change to the total value of the issuer or of an investor's position.

Authorized Stock

Approved number of shares the corporation can sell after a company decides to offer stock the public.

Par Value

Authorized shares assigned a nominal value to provide a minimum amount of legal capital to pay creditors (often $1 or less)

ADR Special Note 2

Because ADRs are common stock, they do not have call risk, meaning the company does not have the right to redeem the shares from the investor. However they do have currency and political risk.

Ex-Rights

Because new shares available through rights are sold at a discount, the rights have value and are traded separately on the open market. If the rights are trading separately, the stock is worth less than the same stock with rights attached.

Liquidation

Common stockholders are paid last in this event.

Dividends

Distributions of a company's profits to shareholders; they are generally paid in cash or in additional shares of stock and must be declared by the company's board of directors.

Shareholder

Entitled to certain legal rights of ownership in addition to the right to transfer the ownership of shares to someone else by sale or gift, other substantial rights are associated with stock ownership.

Warrant

Entitles the holder to buy the issuer's stock at a specified price for a period of time. It is a long-term instrument, generally five years or more in term and the exercise price is usually substantially higher than the stock price at the time of the issue. Warrants become exercisable only if the stock appreciates over the long term a over the exercise price. Frequently attached to bonds or preferred stock as a sweetner, allowing the issuer to pay a lower interest rate or dividend. Warrants may trade separately on the open market.

Stock

Equity capital, which means it gives buyers an ownership stake in the corporation. An investor owning even one share of stock will have a claim on the company's assets and profits.

Preferred Stock

Equity security that represents ownership that is senior in priority to common stock. It pays regular, fixed dividend payment.

Common Stock

Equity security that represents ownership, giving investors a claim on the company's assets and earnings, and offering the potential for growth (capital gains) and/or income (dividends)

American Depository Receipts (ADRs)

Facilitate the US trading of foreign common stock

Non-Systematic / Non-Systemic Risk (Business Risk / Specific Risk)

Generally, will not impact an investor's entire portfolio. Best protection is portfolio diversification. Its the possibility of a company making poor decisions that negatively impact the performance of its stock.

Warrants

Give an investor the ability to purchase a company's stock at a fixed price for a set period of time; generally, they are provided by the company in conjunction with another security (e.g. bond or preferred stock) to make the security more attractive.

Pre-Emptive Rights

Give investors the right to maintain a proportionate interest in a company' stock, not increase it.

Rights Offering

Gives shareholders the right to acquire additional shares, proportion to their current holdings, at a stated price.

Proxy

If a stockholder cannot attend a meeting to vote in person, votes can be cast by proxy through an absentee balot.

Pre-Emptive rights / Subscription Rights

Investors are given the right to acquire additional shares and are typically given a short time frame - typically between 30-45 days - to decide whether or not they want to exercise these rights. (Prevents dilution)

Limited Liability

Investors are only on the hook for the amount invested and cannot lose more than their original investment.

Dividends

Investors can earn a profit by receiving this which is a share of the corporations profits. If they are to be paid, a specified amount is allocated for each outstanding share.

Capital Gains

Investors that buy stock can earn a profit by buying a stock at one price and selling it at a higher price. Investors only pay taxes on realized capital gains, which is generated when an investor sells a security for a profit. Unrealized capital gains is the increase in value of the security is not taxed until the investor actually sells it. Sometimes referred to as paper gains and have no immediate tax impact.

ADR special note

It is possible for an ADR holder to receive a lower dividend than was actually declared by the foreign company because the foreign government might have withheld a percentage of the dividend for taxes.

Cyclical Stocks

Mirror the economy, strengthening when the economy is growing and declining in value as the economy contracts. Ex. Companies that supply capital equipment or high-ticket consumer items (cars, large appliances)

Dividends in Arrears

Missed dividends for past years that preferred stockholders have a right to receive under the cumulative-dividend preference if and when dividends are declared.

Risk of Owning ADRs

Political Risk - Is the government in the home country of the ADR stable? Currency Risk - Is the currency of the home country of hte ADR stable? If a country's currency is devalued, it will impact the value of ADRs even if the company had been performing well. It will also impact the value of the dividend, which is converted from the issuer's home currency into US dollars. Inflationary Risk - Is inflation a substantial risk in the home country of the ADR? If so, it can cause devaluation of the country's currency, which will impact the ADR's value.

Biggest Difference (Common vs. PS)

Preferred stock almost always pays a quarterly dividend. Companies are reluctant to skip a preferred stock dividend and investors can generally count on a preferred stock dividend being paid. Par value is more significant to preferred stockholders than to common stockholders because the dividend rate is expressed as a percentage of par value.

Preferred Stock Dividend Note

Preferred stock dividend is quoted as a percentage of the price at which the stock is currently trading.

Income Stock

Produce income, typically in the form of dividends, for their investors. Ex. Utility stocks and REITs

Rights (Purpose, exercise price, timeframe)

Purpose: Allows shareholders to maintain their proportionate ownership of the company when new shares are issued. Exercise Price: Below the current market value Timeframe: Short-term

Warrants (Purpose, exercise price, and timeframe)

Purpose: Issued in connection with another security as a way to make that security more attractive to investors. Exercise Price: Above the current market value Timeframe: Long-term

Sources of Systematic Risk

Recessions, wars, significant political events, and interest rate changes. Can hedge with derivatives

American Depository Receipts (ADRs)

Represents ownership in the shares of non-US companies that trade in US financial markets. Made available to US markets by major commercial banks that provide depository services. These banks purchase a bulk lot of shares form foreign companies, bundle the shares into groups, and re-issue them on either a US exchange or over-the-counter. Share are denominated in US dollars and dividends are pad to the domestic investors in US dollars. Ex. Investors purchasing Toyota stock on the NYSE are actually purchasing ADRs that represent ownership of the shares.

Defensive Stocks

Resistant to changes in economic cycles. Typically supply a basic need, offer a way to cut costs, or have the lowest price. Ex: Staple consumer items or discount retailers like Wal-Mart

Market Risk / Systematic Risk / Systemic Risk

Risk that reflects the fact that the performance of an individual security will be impacted by the performance of the overall market.

Proxy Statements

SEC-required disclosures that are sent to solicit shareholder votes for the election of corporate directors at annual meetings and for material corporate events, such as mergers, The information contained in proxy materials must be filed with the SEC in advance of the shareholder solicitation and the proxy must disclose all important facts upon which shareholders are to vote. Although a formal proxy statement is usually dozens of pages, proxy cards contain the information in a condensed form.

Treasury Shares / Treasury Stock

Shares that are issued to investors and subsequently repurchased by the company. Not included when calculating a company's total outstanding shares.

Growth Stocks

Stocks of companies that reinvest most of their earnings into their businesses. Considered risky, purchase for the potential to produce capital gains.

Blue Chip Stocks

Stocks of large, stable companies with a long history of steady earnings and dividends. Ex. GE, IBM, Coca-Cola, Pfizer

Book-Entry Form

The broker-dealer keeps a record in its books of the ownership of that particular security.

Street Name

The broker-dealer with teh customer's account is the nominal owner and the customer is the beneficial owner. being the beneficial owner means the customer retails all rights of ownership, including the right to vote. Street name registration allows for ease of transfer when securities are bought and sold. Broker-dealer must promptly forward all proxy materials to the beneficial owner.

Ex-dividend date

The first date when an investor buys common stock, the investor will not receive the dividend because he or she will not be on the books and records of the company in time.

Dilution

The reduction of their ownership interest.

Unlisted Stock

The security is not found on a national stock exchange (NYSE / NASDAQ). Trade in the over-the-counter (OTC) marketplace and are quoted on the OTC Bulletin Board / OTC Markets. (Previously known as OTC Pink or Pink Sheets). Goal of capital appreciation - more risky because illiquid and volatile.

Outstanding Shares

The shares are in the hands of the investors.

Issued Stock

The shares of authorized stock that are sold to the public.

Penny Stock

Unlisted stock trading for less than $5/share

Preferred Stock Differs from Common Stock

Voting rights, liquidation priority, and dividend payments (Typically don't have voting rights)

Stock Certificates

What investors received until the late 1990s which were physical certificates that represented the investors ownership interest in the corporation.

Preferred Stock Trades Like Debt

When interest rates increase, a company must now issued preferred stock that pays a higher dividend to compete with higher-yielding debt securities. Outstanding preferred stock that pays a lower dividend will lose value since it odes not provide a competitive income stream. Return on PS is tied primarily to dividend payments which caps upside appreciation and downside risk.

No-Par Value

common stock that has not been assigned a par value

Form 10-K

the annual report that publicly traded companies must file with the SEC

American depositary shares (ADS)

the individual shares of a foreign corporation represented by an ADR