S7 CH2 - Equity Securities

Elisha purchased 100 shares of RMBN common stock on June 6, 2021, at $60 per share. On February 11, 2022, RMBN paid shareholders a 20% stock dividend. Elisha sold the shares received as the stock dividend on December 5, 2022, at $55 per share. What are the tax consequences of this trade? A) $100 short-term capital loss B) $100 long-term capital gain C) $100 short-term capital gains D) $100 long-term capital loss

$100 long-term capital gain When a stock dividend is paid, the cost basis of the shares is adjusted. In this case, Elisha now owns 120 shares and the total cost is still the original $6,000. That makes the adjusted cost basis per share $50 ($6,000 ÷ 120). With the new cost basis of $50 per share, when the sale of those 20 shares takes place at $55 per share, the result is a gain of $100 ($5 per share profit × 20 shares). Alternatively, you could take the $1,100 total proceeds (20 shares × $55 per share) minus the $1,000 cost basis (20 shares × $50 per share adjusted cost per share). Even though these shares were acquired less than 12 months before the sale, their holding period is based on the original purchase date, and that is clearly more than 12 months before the sale. That is why it is long term.

If a dividend is qualified, the tax rate is generally a maximum of ___%. If the dividend is nonqualified, the _________ apply. Which is lower?

15% If the dividend is nonqualified, ordinary income tax rates apply. The tax rate of qualified dividends to lower than the ordinary income tax rate applied to NQ dividends.

Statutory Voting vs Cumulative Voting

Statutory - one vote per share owned for each item on the ballot Cumulative - stockholders can allocate their total votes in any manner they choose

What happens when a company's current stockholders do not exercise their preemptive rights in an additional offering?

A corporation has an underwriter standing by to purchase whatever shares remain unsold as a result of rights expiring.

What is the risk in buying callable preferred stock? What is a benefit?

A risk in buying callable preferred stock is that the issuer may decide to redeem it. However, the call price is higher than the par value to make up for the fact that the investor will have to look for a new investment. Another benefit is that callable preferred generally has a higher dividend rate than straight noncallable preferred.

A registered representative has a customer looking to invest in stock for income. The customer is looking for the highest fixed rate of return available based on her risk profile. Which of the following would be least suitable? A) Convertible preferred B) Cumulative preferred C) Callable preferred D) Straight preferred

A) Convertible preferred Convertible preferred stock is convertible into the issuer's common stock. This conversion feature has value if the market price of the underlying stock should increase. Because of that feature, issuers are able to attract investor interest with a lower dividend on this preferred stock compared with preferred stock that has no conversion feature. Therefore, it would be the least suitable investment for this client.

For tax-reporting purposes, qualified dividends are considered to be what type of income? A) Portfolio B) Phantom C) Passive D) Earned

A) Portfolio

One of your customers has asked you about trading penny stocks. After discussing the risks, the customer decides to go ahead. The firm sends the individual a copy of the special penny stock risk disclosure document. The firm needs the customer's signed and dated acknowledgment of receipt of the document. Trading in penny stocks may not begin in that account until A) at least two business days after sending the statement. B) at least $25,000 in equity is in the account. C) at least two business days after receiving the statement. D) the day the signed acknowledgment has been received.

A) at least two business days after sending the statement.

An associated person has a customer who wants to purchase an unlisted security trading at around $3.20. When the customer completes a purchase, the firm must A) furnish an updated quote, either orally or in writing. B) both of these. C) add an SEC fee for unlisted securities. D) neither of these.

A) furnish an updated quote, either orally or in writing. Members are required to provide penny stock purchasers with a current bid and asked quote on the stock to prevent the practice of quoting prices that are away from the current market to customers.

KAPCO Manufacturing Corporation declares a 5-for-1 stock split on its outstanding shares of $20 par value common stock. This split will cause A) the par value of the shares to change to $4 per share. B) the dividend per share on KAPCO's preferred stock to be reduced. C) the price of the shares to change to $4 per share. D) a change to KAPCO's net worth

A) the par value of the shares to change to $4 per share. Whenever there is a stock split (forward, such as this, or reverse), the par value is adjusted for the split. With a $20 par and a 5-for-1 split, the par value now becomes $4 per share. A way to visualize this is to think of changing a $5 bill for five $1 bills. The overall value hasn't changed, but the face or par value of each bill is now ⅕ of what it was originally. The stock's market value will drop by approximately 20% (⅕) of the pre-split price. The question only tells us the par value, not the market value (and those two values are unrelated).

What are penny stocks?

Stocks trading under $5 per share and is not listed on a major exchange

A corporation is having a rights offering. The terms of the offering require eight rights plus $88 to purchase one share. With the stock's current market price at $112 per share, the theoretical value of one right on the ex-rights date is A) $2.67. B) $3.00. C) $0.30. D) $0.27.

B) $3.00. Because the question is asking about the value on the ex-rights, it means we use the regular formula. That is, the (market price minus the subscription price) divided by the (number of rights it takes to buy one share). Plugging in the numbers gives us ($112 - $88) ÷ (8) = $24 ÷ 8 = $3.00

Aenical Corporation issued $100 million of $100 par value preferred stock a number of years ago. The stock pays quarterly dividends of $1.25. Recent issues of comparable preferred stock carry a dividend yield of 10%. One could expect the market price of the Aenical preferred stock to be closest to A) $25. B) $50. C) $75. D) $10.

B) $50. As with other fixed-income securities, as market yields increase, the price of previously issued securities declines. The logic is that investors will purchase fixed income securities only if they can receive a return comparable to the current market rate. This stock is paying an annual dividend of $5 ($1.25 per quarter times four). Investors will be most interested in this stock if their return will be approximately 10%, the current rate being paid in the market. The math here needs to first answer "$5 is 10% of what number?" Divide $5 by 10% and the answer is $50. At $50 per share, Aenical stock paying a $5 annual dividend is offering a 10% return on investment.

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

B) 10 The stock is trading before the ex-date = the stock is trading cum rights The formula to calculate the value of one right before the ex-date is follows: CMV minus subscription price divided by the number of rights to purchase one share plus 1. Therefore, one right is valued at $10, computed as ($70 − $50) ÷ 2 = $10.

Reasons why a corporation might engage in a stock buy-back program would include all of these except A) having stock available for future acquisitions. B) reducing annual interest expense. C) increasing earnings per share. D) using the stock for employee stock options.

B) reducing annual interest expense. There is no interest expense with stock. When a company buys back its stock, it becomes treasury stock. That stock is no longer outstanding. Buying back the stock should cause the earnings per share to increase (there are now fewer shares outstanding). Many times one company will acquire another one by paying for the purchase with its treasury stock rather than cash. Many companies offer employees ownership opportunities through employee stock options. This is a way to ensure that the company has enough stock to meet the needs.

Your customer has experienced $7,500 in capital losses this year. He has realized $2,000 in capital gains and has $65,000 adjusted gross income. How much of his loss will he be able to carry forward to next year? A) None B) $5,500 C) $2,500 D) $4,500

C) $2,500 He will first offset his $2,000 in capital gains, leaving $5,500 in losses. He next offsets $3,000 in adjusted gross income, leaving $2,500 in losses to carry forward to next year. Provided the loss is offset to the maximum each year, there is no limit to how long losses may be carried forward.

The over-the-counter (OTC) market is A) the first market. B) all of these. C) a negotiated market. D) an auction market.

C) a negotiated market. Registered market makers compete among themselves to post the best bid and ask prices.

A type of alternative trading system that trades listed stocks and is required to register with the SEC as a broker-dealer is A) an ETN. B) the fourth market. C) an ECN. D) a dark pool.

C) an ECN. Electronic communication networks (ECNs) are a type of alternative trading system (ATS) that trade listed stocks and other exchange-traded products. Unlike dark pools, which are another type of ATS, ECNs display order in the consolidated quote stream. As ATSs, ECNs are required to register with the SEC as broker-dealers and are also members of FINRA. Trading in the fourth market (institution to institution) is done largely through ECNs.

A type of alternative trading system that trades listed stocks and is required to register with the SEC as a broker-dealer is A) the fourth market. B) a dark pool. C) an ECN. D) an ETN

C) an ECN. Electronic communication networks (ECNs) are a type of alternative trading system (ATS) that trade listed stocks and other exchange-traded products.

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

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

A network of market makers that offers to trade securities not listed on an exchange is called A) National Association of Securities Dealers Automated Quotations. B) National Daily Quotation Service. C) the over-the-counter (OTC) market. D) NYSE Arca.

C) the over-the-counter (OTC) market.

What is the difference between the primary market and secondary market?

the primary market is the market in which the proceeds of sales go to the issuer of the securities sold. the secondary market where previously issued securities are bought and sold

One of your customers is a confirmed short-term trader. The moment the price of one of her stocks moves to where the gain is more than your commission, she turns in a sell order. She is not at all interested in penny stocks. Why might that be? A) They are priced at less than $5 per share. B) The issuers have little business history. C) They are not listed on major exchanges. D) They tend to be very thinly traded.

D) They tend to be very thinly traded. While all of the answers are true of penny stocks, the one that would tip the scale for your customer is thin trading. Her investment style requires finding a buyer quickly when she wants to sell. A penny stock may have no potential buyers at the critical moment.

All of the following are subject to the 5% markup policy except A) markups. B) markdowns. C) commissions. D) spreads in new stock offerings.

D) spreads in new stock offerings. The 5% markup policy applies to markups, markdowns, and commissions. New offerings sold by prospectus are exempt from this rule.

Stocks that are listed on the NYSE can also trade on all of the following except A) an electronic communications network (ECN). B) the third market. C) the fourth market. D) the CBOE (Chicago Board Options Exchange).

D) the CBOE (Chicago Board Options Exchange). NYSE-listed stocks would never be listed on an options exchange such as the CBOE; those are strictly for trading options, not stock. The third market is the trading of listed securities in the over-the-counter market. The fourth market is the use of ECNs for institutions to trade without the middleman, a broker-dealer.

Which of the following describe a securities exchange? i. Prices are set by negotiation between interested parties. ii. The highest bid and the lowest offer prevail. iii. Only listed securities can be traded. iv. Minimum prices are established at the beginning of the day.

II and III An exchange is not a negotiated market but is instead an auction market in which securities listed on that exchange are traded. No minimum price is set for securities. Rather, the highest bid and the lowest offer prevail.

The 5% markup policy applies to which of the following? i. Exempt transactions ii. Agency transactions iii. Principal secondary market trades iv. New issues

II and III The 5% markup policy applies to all secondary market transactions. It does not apply to exempt transactions, transactions requiring the delivery of a prospectus, or issues sold at a fixed offering price.

What is preferred stock usually purchased for?

Income - since preferred stock is issued with a fixed rate of return (fixed return = dividend)

What type of stock is an exception to the fact that shares of stock are freely transferable?

Restricted stock is not freely transferable (sold at any time without permission) - as it cannot be sold without meeting the requirements of SEC Rule 144.

Short term gains are taxed at _____________ and long term gains are taxed at _____________________.

Short-term gains are taxed at ordinary income rates and long-term gains at 15% (unless in the highest tax brackets).

What is the 5% policy/Rule 2121` and what type of transactions does it apply to?

The 5% policy was adopted to ensure that the investing public receives fair treatment and is charged reasonable rates for brokerage services. Disregard the number 5 - charges of more than 5% can be reasonable. The 5% markup policy applies to agency and principal nonexempt securities and transactions, both exchange and OTC traded. It does not apply to prospectus offerings (mutual funds and new issues).

Rank the following securities from the same issuer from most suitable to least suitable for a client whose primary objective is income with relative safety. i. Cumulative preferred stock ii. Convertible preferred stock iii. Common stock iv. Warrant

i, ii, iii, iv