Series 7 Unit 3 Equity securities

Issued stock

- Authorized stock that has been sold to investors -When a corporation issues or sells fewer shares than the total number authorized, it normally reserves the unissued shares for future needs -Raising new capital for expansion -Paying stock dividends -exchanging common stock for outstanding convertible bonds or preferred stock -Authorized but unissued stock does not carry the rights and privileges of issued shares and is not considered in determining a company's total capitalization. -Ready to use when needed, but if they are not used, they are blank pieces of paper

Origins of common stock

- Two primary types of equity securities: Common and preferred stocks -Each share of each common stock entitles its owner to a portion of the company's profits and dividends and an equal vote on directors and other important matters -

Straight (noncumulative) preferred stock

Has no special features beyond the stated dividend payment. -If the company can only pay part, or none of the dividend this year, it does not have to be made up in the future years. -Preferred stock with no special features is known as straight preferred

Application of the 5% policy

If a member must give a customer a prospectus in any transaction, that transaction is outside the scope of the 5% policy (e.g. new issues, mutual funds, variable annuities, and DPPs) -The 5% policy applies to both principal (dealer) and agency (broker) transactions. It applies to markups, markdowns, and commissions, but not to securities sold by prospectus

Currency risk

In addition to the normal risks associated with stock ownership, ADR investor investors are subject to currency risk. -If that currency drops in value compared to the US dollar, the investor receives less money, even if the dividend stays level

Portfolio income

Includes dividends, interest, and net capital gains derived from the sale of securities

Forward stock split

Increases the number of shares; This reduces the price without affecting the total market value of shares outstanding -An investor will receive more shares but the share is reduced The total market value of the ownership interest is the same before and after the split

Treasury stock

Stock a corporation has issued and subsequently reacquired. -Corporation can hold this stock indefinitely or can reissue or retire it -Treasury stock does not carry the rights of outstanding common shares, such as voting rights and the right to receive dividends

Participating preferred

Stock is eligible to receive a percentage of the common dividend. The maximum percentage is stated when the stock is issued -Before the participating dividend can be paid, a common dividend must be declared

Inspection of corporate books

Stockholders have the right to receive annual financial statements and obtain lists of stockholders.

Adjustable-Rate preferred/Variable dividend rates

The adjustment is made based on a chosen standard -The interest rate on US government Treasury bills is one frequently used. These adjustments are done quarterly. -The advantage to an adjustable-rate preferred stock is that it does not have the interest-rate risk of other fixed-income securities

Primary Market

The market in which the proceeds of sales go to the issuer of the securities sold. That is generally called the new issues market

Capital gains and losses

The sale of a security at a price higher than its cost results in a profit. This is a capital gain -If sold at a lower price than it cost, there is a loss: Capital loss -For any security sold within 12 months of purchase, the holding period is short term -For 12 months plus one day, it is long term -The tax rate on short term gains is the same as ordinary income like salary. -The tax on long term capital gains is the same as that of qualified dividends, generally 15%

Preemptive rights/stock rights

These entitle existing stockholders to maintain their proportionate ownership in a company -A rights offering allows stockholders to purchase common stock below the current market price. -The rights are valued separately from the stock, and trade in the secondary market during the subscription period.

Terms of the offering

These terms would include the number of new shares a stockholder may buy and the subscription (exercise) price. -An investor who buys stock cum rights receives the right. -An investor who buys stock ex-rights does not

Dividends

Dividends on preferred stock are always paid in cash -Dividends on common stock may be paid in cash or as additional shares of stock (Stock dividend)

Secondary market

Previously issued securities are brought and sold

Preferred stock

Represents ownership, (equity), in the corporation -Always issued with a fixed (stated) rate of return -These securities are generally purchased for income -Although the dividend of most preferred stocks is fixed, some are issued with a variable dividend payout known as adjustable preferred stock -Preferred stock is nonvoting -When BOD declares dividends, owners of preferred stock must receive their stated dividend in full before common stockholders may receive dividend -If a corporation goes bankrupt, preferred stockholders have a priority claim over common stockholders on the assets remaining after creditors have been paid

Frequency of customer account statements

Rule 15g-5 requires members to provide penny stock purchasers with monthly statements showing the estimated market value of each penny stock purchased

Customer suitability determination

Rule 15g-9 addresses sale practices to curb abusive sales practices. This rule requires members who are soliciting new customers to make a suitability determination. -The member must inquire as to the prospective customer's income, net worth, objectives, and risk tolerance.

Disclosure of compensations

Rules 15g-4 and 15g-5 require members to provide penny stock purchasers with information on the compensation to be earned by both the member and the registered representative as the result of the transaction. This is to prevent excessive markups

Stock exchanges

-After the initial offering, many stocks are brought and sold on exchanges in a two-way auction process. -Major exchanges include the NYSE, NYSE American LLC, the Chicago board exchange options exchange and the NASDAQ stock market -Exchange market is composed of the NYSE and other exchanges on which listed securities are traded. -Listed security refers to any security that is bought and sold on an exchange -Those of the NYSE are the most stringent -Many of the stocks listed on the NYSE are considered "bluechips". The term refers to the common stock of well-known companies with a history of growth and dividend payments -The security Exchange Act of 1934 requires registration of an exchange with the SEC. Under that act, the SEC has many powers including enforcement of the laws -As of the date of this printing, there are 21 exchanges registered as national stock exchanges with the SEC -Historically, stock exchanges operated as auction markets. That is the

Outstanding stock

-Any shares that a company has issued and are in the hands of the investors

Electronic communications market

-Broker dealers can send an order through an ECN instead of going through a market maker -An ECN is an electronic trading system that automatically matches buy and sell orders at specified prices. -ECNs are SEC-sanctioned alternative trading systems

Voting rights

-Common stockholders have the right vote -Voting generally takes place at the company's annual meeting and could include: issuance o convertible securities or additional common stock; substantial changes in the corporations business, such as mergers or acquisitions; and declarations of stock splits (forward and reverse) -A convertible security gives the owner the right to swap that security for common shares of the issuer -Shareholders do no vote on dividend related matters, such as when they are declared and how much they will be.; They do vote on stock splits, board members, and issuance of additional equity related securities such as common stock, preferred stock, and convertible securities

Dark pools

-Dark pools of liquidity, is trading volume that occurs that is not openly available to the public -The bulk of this volume represents large trades engaged in by institutional traders and trading desks away from the exchange markets -Institutions choosing to use dark pools are able to execute large block orders without affecting public quotes or prices- They do not reveal their investment strategy -Dark pools account for about 17% of the trading volume in the US stock market

A stockholder receives rights may...

-Exercise the rights to buy stock by sending the rights certificates and a check for the required amount to the rights agent -Sell the rights and profit from their market value (rights certificates are negotiable securities) -Let the rights expire and lose their value

Pump and dump

-Fraudulent activity where unscrupulous firms or investors spread rumors in an attempt to "pump" up the stock's price. -If enough investors bite, the price rises and the promoters then "dump" their shares. This causes the price to drop and the unknowing investor suffers a big loss

Convertible preferred

-Gives the owner the right to exchange each preferred share for shares of common stock. -Conversion rate is fixed at the time of the issue. -It may be shown as the number of shares, such as convertible into four shares. -The convertible feature results in these shares having a lower dividend rate -Because the ability to convert a preferred into common stock offers growth potential not otherwise available to a preferred stockholder.

Residual Claims to Assets

-If a corporation is liquidated, the common stockholder has a residual right to claim corporate assets -This means they come after all debts and other security holders have been satisfied -Common stockholder has the last claim

Penny stock risks

-If the stock trades for less than $5 per share and is not listed on a major exchange such as the NYSE or the NASDAQ Stock Market, it is a penny stock

oVER THE COUNTER MARKET

-In terms of the number of securities traded, largest in the US -OTC market functions as an interdealer market in which unlisted securities- that is, securities not listed on any exchange- trade -One of the best known of the OTC markets is the OTC Bulletin Board where stocks that do not qualify for listing on the exchanges are traded -OTC link, which for many years was known as the Pink Sheets because the quotes were printed on pink colored paper: Thinly traded stocks -Like securities traded on the exchange, these are registered with the SEC, but tend to be on the highly speculative side -These stocks are not eligible for margin trading -Trading takes place over the phone, over computer networks, and in trading rooms across the country -Interdealer network -While the NYSE has the DMM to facilitate trading on the floor, the OTC market has market makers -A market maker chooses to deal in selected OTC stocks OTC is a negotiated market

Cash Dividends

-On the exam, most of the cash dividends will be qualified -If the dividend qualifies, the tax rates are lower than if nonqualified -If the dividend is qualified, the tax rate is generally a maximum of 15%. It can be as high as 20% or more for taxpayers in the highest brackets, but that is unlikely to be tested. -If the dividend is nonqualified, ordinary income tax rates apply -For test purposes, assume that any dividend from a US corporation, including mutual funds, is qualified, unless the question states otherwise -Tax rates are lower than the ordinary income rate applied to nonqualified dividends

Stock dividends

-One option a corporation has is to pay common stockholders a dividend in additional shares of the stock -Just as with the stock split, there is no real change to the overall value

Lack of Transparency

-Penny stocks trade on the OTC Bulletin Board and the OTC link. The requirements for trading there are less stringent than the major exchanges. -Coverage by analysts is spotty, so getting information is more difficult than with listed stock

American Depository Receipts

A receipt for shares of a foreign stock deposited with a custodian -The ADR shows ownership in the deposited security -ADRs are securities that trade on the US securities markets. ADRs are in English and trade in US dollars

Fixed rate of return

-Preferred stocks fixed dividend is a key attraction for income-oriented investors -A preferred stock with a par value of $100 that pays $6 in annual dividends is known as 6% preferred. On the exam- assume all dividends are paid quarterly. On the $6 preferred, that would be 4 dividends of $11.50. On the $25 par, 4% stock, that would be 4 dividends of $0.25 -No obligation to be paid -The stated rate of dividend payment causes the market price of preferred stock to move opposite changes in interest rates. -As interest rates climb, the prices of preferred stocks decline. The reverse is true when interest rates go down. -Preferred stock represents ownership in a company like a common stock, but its price is sensitive to interest rates -Preferred stock has no preset date at which it matures and no scheduled redemption date of maturity value

The securities act of 1933

-Regulates activity in the primary activity -The securities exchange act of 1934 regulates the activity in the secondary market

Disclosure of quotations

-Rule 15g-3 requires members 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

Fair prices and commissions (FINRA Rule 2121)

-Rule 2121, also known as the 5% policy, was adopted to ensure that the investing public receives fair treatment and is charged reasonable rates for brokerage services -Test questions try to trap students into thinking that the rule mandates markups or commissions of 5% or less

Transferability

-Shareholders do not need the permission of the issuer to sell their stock in the open market -Liquidity is the ability to get your money quickly at a fair price. -One exception is restricted stock, where sales are contingent upon meeting the requirements of SEC Rule 44

Net capital losses

-Short term gains are taxed at ordinary income rates and long term gains at 15% (unless in the highest tax brackets) -Capital losses that exceed capital gains are deductible against earned income. The annual maximum is $3000 per year -Th excess over $3000 may be carried forward indefinitely as a deduction to offset capital gains in future years

Proxies

-Stockholders often find it difficult to attend the annual stockholders meeting, so most vote on company matters by means of proxy, a form of absence ballot -A proxy can automatically be cancelled id the stockholder attends the meeting, authorizes a subsequent proxy, or dies.

Risk disclosure document

-The SEC requires the firm to wait at least two business days after sending the statement before executing the first trade

Authorised stock

-The corporate charter specifies the number of shares the company is authorized to issue; It is a decision made by the founders of the business -If the company wants to issue more shares than authorized, the charter must be amended by the stockholder vote

Penny stock rules

-The highly speculative nature and risks of penny stocks carry special rules to protect investors. In the industry, they are known as the 15g rules.

Lack of liquidity

-Thinly traded securities -Thinly traded securities usually have a large spread between the buy and sell price

Limited liability

-Those who own stock in a corporation cannot be held liable for the company's debts. -If the business goes bankrupt, the creditors cannot go after the shareholders

Stock splits

-To make the stock price attractive to a wider base of investors, the company can declare tock split

Warrants

A certificate granting its owner the right to purchase securities from the issuer at a specified place. -There is no standard length, but they generally have an expiration date at least two years after issue -A more typical length is 5 years -Perpetual warrants never expire -Unlike rights, the purchase price is always higher than the current market price on the date of issue of the warrant -As with rights, although referred to as an equity security, these warrants are not ownership. Only when exercised does the investor have more shares -Warrants themselves do not pay dividends and do not vote

Subscription right certificate

A certificate representing the privilege to buy additional shares of a corporation -These rights have a short lifespan. -Most rights expire within 30-45 days of issue

Established customer exception

A member may solicit an established customer without having to prepare a suitability statement. An established customer is one who has -effected a nonpenny stock transaction or made a deposit of funds or securities in an account more than one year before the proposed penny stock trade -made three unsolicited purchases of penny stocks, on three separate days, involving three separate issues. Once a customer buys three different penny stocks, he is no longer covered by the suitability statement requirement

Rights of ADR owners

ADR owners have most of the rights common stockholders normally hold. These include the right to receive dividends when declared -These dividends are in US dollars -Generally, ADRs do not have voting rights, though some ADR issues will pass on voting rights to the holders of ADRs

Delivery of Foreign Security

ADR owners have the right to exchange their ADR certificates for the foreign shares they represent. They can do this by returning the ADRs to the depository banks, which cancel the ADRs and deliver the underlying stock.

Registered owner

ADRs are registered on the books of the US banks responsible for them

Sponsored ADRs

All exchange listed ADRs are sponsored- that is, the foreign company sponsors the issue to increase its ownership base. -Sponsored ADRs are sometimes referred to as American depository shares

Statutory voting

Allows a stockholder to cast one vote per share owned for each item on a ballot, such as candidates for BOD -Benefits larger shareholders

Cumulative voting

Allows stockholders to allocate their total votes in any manner they choose -Cumulative voting benefits the smaller investor

Cumulative preferred

Any dividends skipped must be paid before paying a common dividend. The technical term for missed dividends in arrears -Any special feature attached to preferred, such as cumulative feature, has a price. The cost of such benefit is less dividend income Cumulative preferred typically has lower standard dividend than straight preferred -The company keeps record of the skipped dividends. when the time comes that it is able to pay, all of the arrearage are paid to holders of cumulative preferred. -For those seeking income, cumulative is safer than straight. That is why the dividend rate is somewhat lower

Callable preferred/ redeemable preferred

Company can buy back the stock from investors at a stated price on the call date or any date thereafter. -The call feature would most likely be used when interest rates decline -In most cases the call price is a bit higher than the par value -A risk in buying callable preferred stock is that the issuer may decide to redeem it. The ends dividend payments. -Callable preferred generally has a higher dividend rate than straight, noncallable preferred

Reverse Split

Investors own fewer shares worth more per share

Nonvoting common stock

Issuing nonvoting stock allows a company to raise additional capital while maintaining management control continuity without diluting voting power

No track record

Many penny stock companies are new. Some have little or no operating history. The SEC warns that investors in penny stocks should be prepared to lose all their investments

Stand by underwriter

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 -By engaging a standby underwriter, an issuer is assured of selling all the shares being offered

Preemptive rights

When a corporation raises capital through the sale of additional common stock, it may be required by law or its corporate charter to offer the securities to its common stockholders before the general public: This is known as anti-dilution provision -Stockholders then have a preemptive right to purchase enough newly issued shares to maintain their proportionate ownership in the corporation

Common Stock classifications

authorized, issued, outstanding, treasury

Inspection rights

do not include the right to examine detailed financial records or the minutes of BOD meetings

Origination of warrants

warrants are usually offered to the public as sweeteners, or inducements, in connection with an offering of other securities, such as bonds or preferred stock -Such offerings are often bundled as units -After issuance, the warrants are detachable and may trade separately from the bond or preferred stock. -When first issued, a warrants exercise price is set somewhat above the stock's price. -If the stock's price increases above the exercise price, the owner can exercise the warrant and buy the stock below the market price or sell the warrant in the market. -In 5 years, a stock's market's price could increase substantially, making that warrant quite variable