S65 Chapter 11 - Equities and Derivatives
A corporation has a 7% cumulative preferred stock issue outstanding. The company paid a $5 dividend three years ago, $6 two years ago, and $7 last year. If the company wants to pay a common stock dividend in the current year, the cumulative preferred stockholders must first receive a dividend of:
$10 The cumulative preferred stockholders should receive a yearly dividend of 7%. Since it's a cumulative issue, any dividend that's not paid (in arrears) must be made up prior to a common dividend being paid. If a common dividend is to be paid in the current year, the cumulative preferred stockholders must first receive $10 ($7 for the current year plus $2 missed from three years ago plus $1 missed from two years ago). Since the cumulative preferred stockholders received the full dividend last year, there are no further dividend payments in arrears to consider.
What is the spread in the following market?
4 cents The spread is the difference between the highest bid and lowest ask price. In this question, the highest bid is 9.85 and the lowest ask if 9.89; therefore, the spread is $0.04 (4 cents). The numbers to the right represent the number of 100 share lots being bid or offered and don't impact the spread.
A stock traded infrequently would MOST likely have:
A wide spread as the security might be difficult to acquire Stocks that trade infrequently (thinly traded) will generally have a wider spread than those stocks that are heavily traded. The spread is the difference between the best bid price and the best asked price in the market.
An investor owns a $100 convertible preferred stock which is convertible into two shares of common stock. The common is selling at $52 and the preferred is selling at $104. The preferred stock is called at $105. What should the investor do?
Allow the preferred to be called The value of the preferred ($104) equals the value of converting to common (two shares at $52 per share). The investor would receive the greatest amount ($105) by allowing the preferred to be called. Waiting for a more favorable call is not a possibility.
A Japanese company would like to have its stock traded in the U.S. securities markets. This would most likely be accomplished through the issuance of:
American Depositary Receipts American Depositary Receipts (ADRs) facilitate U.S. investment in foreign securities. When the foreign securities are deposited in a U.S. bank based in that country, a receipt for those securities is issued and traded in the U.S. as if it were the foreign security itself.
Foreign stocks trade in U.S. markets as:
American Depositary Receipts (ADRs) American Depositary Receipts are used to facilitate the trading of foreign stocks in the United States. Unregistered securities are securities sold to investors that do not require registration with the SEC (for example, a private securities offering). An exchange-traded fund (ETF) is a type of investment company that represents a basket of securities and is traded on an exchange. The basket of securities usually represents an index such as the Nasdaq 100 or the S&P 500. A closed-end mutual fund is also a type of investment company that issues a fixed number of shares.
Ms. Brown sells short 100 shares of ABC at 95. Two weeks later, the stock drops to a price of 89. In an attempt to protect her profit, Ms. Brown would enter a:
Buy stop order at 90 Ms. Brown is seeking to protect her profitable short position should the market price of ABC increase. While a buy stop order at 90 would not guarantee a profit, it would be activated as a market order if the stock rose to 90 or higher. The buy limit order would not be executed if the stock were to rise above 90. Thus, the buy limit would not offer any protection against an increase in the stock.
A client is invested in a large number of stocks in different industries. If the client is concerned that they may fall in value, an adviser may recommend a hedging strategy to the client, such as;
Buying puts on the S&P 500 Index In buying puts on the S&P 500 Index, the client has the right to exercise the option at its strike price and receive in cash the intrinsic value of the contract. Should the market decline, the puts would increase in value as they move into the money, thus offsetting losses on the stock portfolio.
All of the following financial instruments are derivatives, EXCEPT:
Closed-end fund shares A derivative security is a financial product that is valued based on the worth of another (underlying) security. The value of an option contract is determined by the underlying stock (or other financial product). A LEAP is a type of option contract with an expiration date that's longer than nine months. The value of a futures contract is also based on the financial instrument or commodity that is referenced in the contract. On the other hand, the value of a closed-end fund's shares is simply their market price.
A broker-dealer acting in an agency capacity will charge customers a:
Commission When acting in an agency capacity, the broker-dealer will normally charge the customer a commission. A broker-dealer that is always willing to buy and/or sell a security is considered a market maker. A market maker will normally act in a principal capacity and charge the customer a markdown when buying stock from a customer and charge a markup when selling stock to a customer.
Last year, a company failed to pay the full dividend to its preferred shareholders, but now wants to pay a cash dividend on its common shares. Which preferred stock must be paid all of the dividends in arrears before the dividend can be paid on its common shares?
Cumulative preferred If a corporation has failed to pay dividends in full on its preferred shares, cumulative preferred stock must be paid any dividends in arrears (missing) before common shares are paid cash dividends. Participating preferred allows the holder to receive an additional amount (along with common shares) if company profits reach a certain level. Convertible preferred can be converted into common stock of the issuer, and callable preferred can be called back from the holder by the issuer.
Which of the following products is NOT a derivative?
ETFs An Exchange-Traded Fund (ETF) is a type of investment company, where investors' money is pooled and invested in securities. Investors in ETFs can buy shares in the secondary market. The shares are priced according to the performance of the portfolio of securities purchased. An ETF is NOT a derivative, since its value is not based on a specific security, but on the entire portfolio. Long-Term Equity Anticipation Securities (LEAPS) are long-term call or put options and are derivatives. A swap and a collateralized mortgage obligation (CMO) are both derivatives.
A trader has a long futures position that he wants to offset. This means that:
He will sell futures on the same exchange in the same delivery month A long position is offset through a sale of the same futures contract on the same exchange in the same delivery month.
All of the following financial instruments are derivatives, EXCEPT:
I and III A stop order becomes a market order (in turn receiving immediate execution) when a round-lot trades at or through its stop price. A stop-limit order becomes a limit order when a round-lot trades at or through its stop price, and requires that its limit price be satisfied to receive an execution. A stop order is sometimes described as a suspended market order since execution depends on the stop price being triggered first.
Which of the following is NOT a characteristic of preferred stock?
It carries voting rights The board of directors must declare dividends for both common and preferred stock. Neither common nor preferred stockholders are guaranteed a dividend. Preferred stock normally has a fixed dividend. Preferred stock does not have voting rights, only common shares may vote.
It is most beneficial to the holder of a call if the price of the underlying security is:
Rising The holder (purchaser) of a call expects the market price of the underlying security to rise and, therefore, will profit from a rise in the security.
A reverse stock split creates a:
Smaller number of shares A reverse stock split creates a smaller number of shares. For example, if a company had 10,000,000 shares outstanding and declared a 1-for-10 reverse stock split, after the split the company would have 1,000,000 shares outstanding. Each stockholder would receive one share for every 10 shares previously owned. A company will do this because many investors shy away from low-priced stocks and a company may want to raise the price of its stock. Additionally, a company may need to raise the stock price to avoid delisting from an exchange.
All of the following are examples of derivatives, EXCEPT:
UIT municipal bond units Unit investment trusts (UITs) are a type of investment company. UIT units represent a direct investment in a fixed portfolio of securities and are not considered derivatives. All of the other choices are considered derivatives.
Which of the following products is NOT a derivative?
UITs A unit investment trust (UIT) is a type of investment company where investors' money is pooled and invested in securities. Investors in UITs have shares of beneficial interest in the portfolio. The shares are priced according to the performance of the portfolio of securities purchased. A UIT is not a derivative, since its value is not based on a specific security, but on the entire portfolio. Long-Term Equity Anticipation Securities (LEAPS) are long-term call or put options and are derivatives. An index option and a collateralized mortgage obligation (CMO) are both derivatives.
Your client owns a portfolio of blue-chip equity securities and would like to increase the overall rate of return through the use of options. The most conservative strategy to achieve this objective is to:
Write covered calls The most conservative strategy for the investor to achieve his objective is to write covered calls. The call premium received will increase the yield on his portfolio of stocks because it will add to the income generated by the dividends received from the stock.
