1 Securities Markets, Investment Securities, and Economic Factors Flashcards
An associated person
Any person controlling, controlled by, or in common control with that member.
A broker
an Agent for a customer and charges the customer a commission for its services
A Dealer
charges the customer a markup or markdown
A member
Any individual, partnership, corporation, or legal entity admitted to membership in FINRA
Outstanding stock
Equity securities in the hands of the public
Authorized Stock
Number of shares that a corporation is permitted to issue
Book Value
Current hypothetical liquidation value of a share or Hypothetical net worth of each share of common stock
Par Value
Dollar amount assigned to a security by its issuer as an arbitrary accounting value
Which of the following represent ownership (equity) in a company? I. Corporate bonds II. Common stock III. Preferred stock IV. Mortgage bonds A. I and II B. I and III C. II and III D. III and IV
C. II and III
Owning either common or preferred stocks represents ownership (or equity) in a corporation. The other two choices represent debt instruments. Clients purchasing corporate or mortgage bonds are considered lenders, not owners.
Which of the following statements describe Treasury stock?
I. It has voting rights and is entitled to a dividend when declared.
II. It has no voting rights and no dividend entitlement.
III. It has been issued and repurchased by the company.
IV. It is authorized but unissued stock.
A. I and III
B. I and IV
C. II and III
D. II and IV
C. II and III
Treasury stock is stock a corporation has issued but subsequently repurchased from investors in the secondary market. The corporation can either reissue the stock at
a later date or retire it. Stock that has been repurchased by the corporation has no voting rights and is not entitled to any declared dividends.
Stockholders’ preemptive rights include the right to
A. serve as an officer on the board of directors
B. maintain proportionate ownership interest in the corporation
C. purchase Treasury stock
D. examine the corporation’s books
B. maintain proportionate ownership interest in the corporation
Preemptive rights enable stockholders to maintain their proportionate ownership when the corporation wants to issue more stock. If a stockholder owns 5% of the outstanding stock and the corporation wants to issue more stock, the stockholder has the right to purchase enough of the new shares to maintain a 5% ownership position in the company.
At the annual meeting of ABC Corporation, 5 directors are to be elected. Under the cumulative voting system, an investor with 100 shares of ABC would have a total of
A. 100 votes to be cast for each of 5 directors
B. 500 votes to be cast in any way the investor chooses for 5 directors
C. 500 votes to be cast for each of 5 directors
D. 100 votes to be cast for only 1 director
B. 500 votes to be cast in any way the investor chooses for 5 directors
With cumulative voting rights, this investor may cast 500 votes for the 5 directors in any way the investor chooses.
Cumulative voting rights A. benefit the large investor B. aid the corporation’s best customers C. give preferred stockholders an advantage over common stockholders D. benefit the small investor
D. benefit the small investor
The cumulative method of voting, like the statutory, gives an investor 1 vote per share owned, times the number of directorships to be elected. For instance, if an investor owns 100 stock shares, and there are 5 directorships to be elected, the investor will have a total of 500 votes. Under cumulative voting, however, the stockholder may cast all of his votes for 1 candidate, thereby giving the small investor more voting power.
What is the basic formula of the balance sheet? A. Assets = liabilities – net worth B. Assets + liabilities = net worth C. Assets = net worth D. Assets = liabilities + net worth
D. Assets = liabilities + net worth
Assets – liabilities = net worth, or
Assets = liabilities + net worth.
The basic formula of the balance sheet is assets = liabilities + net worth. By the same algebra, a company’s shareholder equity can be calculated as such: net worth = assets – liabilities.
All of the following are privileges or benefits of stock ownership EXCEPT A. dividends B. growth C. guaranteed income D. voting rights
C. guaranteed income
Although stocks often pay regular dividends, they are not guaranteed. If the board decides the company cannot afford to pay a dividend this quarter, no dividend will be paid.
Which of the following factors are disadvantages of investment in common stock, compared with fixed income securities, such as bonds? I. No assurance of return II. Lower priority of income payment III. No voting rights IV. Less inflation protection A. I and II B. I and III C. II and IV D. III and IV
A. I and II
Unlike bond interest, dividends on stock are not promised or ensured and need not be paid. Also, when money is to be paid out, whether as income to the investor or as return of capital at dissolution, common stock has the lowest priority. On the bright side, common stock, unlike debt instruments, gives its owner the right to vote on the important decisions of the issuing company and has historically offered better inflation protection than fixed income securities.
Which of the following types of preferred stock is most influenced by the price of an issuer’s common stock? A. Participating B. Straight C. Convertible D. Callable
C. Convertible
Because convertible preferred shares can be exchanged for common shares, its price can be closely linked to the price of the issuer’s common and is less influenced by changes in interest rates.
Which of the following types of preferred stock might pay a dividend that is higher than that printed on the certificate? I. Straight preferred II. Cumulative preferred III. Participating preferred IV. Callable preferred A. I and III B. I and IV C. II and III D. II and IV
C. II and III
Cumulative preferred might pay dividends in arrears in addition to the fixed dividend. Participating preferred might pay part of the common dividend, over and above the fixed dividend.
In which of the following ways does preferred stock differ from common stock as an investment?
A. Lower dividends
B. Greater sensitivity to interest rate fluctuation
C. Lower priority of dividend payment
D. Greater voting rights
B. Greater sensitivity to interest rate fluctuation
As a fixed income security, preferred stock has markedly greater price sensitivity to interest rates than does common stock.
100
Number of shares in a standard trading unit of stock
Preemptive right
Stockholders may maintain proportionate ownership by purchasing newly issued shares before they are offered to the public
Current yield
Annualized dividend divided by current market price
Quarterly
Typical frequency of dividend payment on common stock
The following question identifies nearly all of the testable points on ADRs:
Which of the following statements about ADRs is TRUE?
A. Owners of ADRs have voting rights.
B. ADRs allow foreign investors to buy domestic issues of stock.
C. Owners of ADRs receive dividends in foreign currency.
D. ADR owners are subject to currency risk.
D. Owners of ADRs face currency risk. The exchange rate between the foreign currency of the ADR issuer and the US dollar causes the dividend pay- ment to rise and fall in dollar value. Owners of ADRs have no preemptive rights or voting rights. ADRs allow domestic investors to purchase foreign issues, not the reverse. ADR owners receive dividends in dollars.
ADRs are used to facilitate
A. the foreign trading of domestic securities
B. the foreign trading of US government securities
C. the domestic trading of US government securities
D. the domestic trading of foreign securities
D. the domestic trading of foreign securities
ADRs are tradable securities issued by banks, with the receipt’s value based on the underlying foreign securities held by the bank.
The owner of an ADR is likely to receive which of the following?
A. Dividends
B. Capital gains or losses
C. Both dividends and capital gains or losses
D. Neither dividends nor capital gains or losses
C. Both dividends and capital gains or losses
An ADR represents ownership of a foreign corporation. The ADR holder receives
a share of the dividends and capital appreciation (or capital loss) when sold.
Rights:
Short-term instruments, exercise price is below market price; issued to current shareholders only, who may exercise them, sell them on the open market, or let them expire
Warrants
Long-term instruments; exercise price is above market price at time of issue; used as sweeteners with issues of more speculative corporate bonds; also, own- ers of warrants are not entitled to dividends, though they may sell the warrant on the open market
Which of the following statements regarding warrants is TRUE?
A. Warrants are offered to current shareholders only.
B. Warrants have longer terms than rights.
C. Warrants do not trade in the secondary market.
D. At the time of issuance, the exercise price of a warrant is typically below the
market price of the underlying stock.
B. Warrants have longer terms than rights.
Warrants are issued with long-term maturities. They may be used as sweeteners in an offering of the issuer’s preferred stock or bonds. Warrants are not offered only to current shareholders. The exercise price of a warrant is always above the market price of the stock at the time of issue.
Which of the following statements about rights is TRUE?
A. Common stockholders do not have the right to subscribe to rights offerings.
B. Preferred stock is not subject to rights offerings.
C. Rights are long-term instruments.
D. The exercise price of rights is greater than the current market price of the stock at the time of issuance.
B. Preferred stock is not subject to rights offerings
Preferred stockholders have no right to maintain a percentage of ownership when new shares are issued (no preemptive rights). However, they do receive preference in dividend payment and company liquidation.
Rights and warrants are similar in that they
A. are both long-term instruments
B. afford access to stock under possibly favorable conditions
C. are both used to sweeten another securities offering
D. both pay relatively low dividends
B. afford access to stock under possibly favorable conditions
Rights afford access to new stock, often at a discount, before it is offered to the public. Warrants afford access to stock at a fixed price for a long period of time.
Who of the following are bearish? I. Call buyer II. Call writer III. Put buyer IV. Put writer A. I and III B. I and IV C. II and III D. II and IV
C. II and III
The call writer expects the stock to decrease in price, and that the call will therefore not be exercised. This permits him to keep the premium. The put buyer thinks the stock will go down in price, and thus reserves to himself the right to sell it at the higher put strike price.
Upon exercise of an option, who of the following would buy stock?
A. The call buyer because he is obliged to.
B. The put seller because he is obliged to.
C. The call seller because he elects to.
D. The put buyer because he elects to.
B. The put seller because he is obliged to.
The put seller has sold another investor the right to sell stock to him at the put strike price. Thus, if the put is exercised, he will be obliged to buy the stock.
Who of the following have acquired an obligation? I. Call buyer II. Call writer III. Put buyer IV. Put writer A. I and III B. I and IV C. II and III D. II and IV
D. II and IV
The call seller is obliged to sell stock, and the put seller is obliged to buy stock, should the option be exercised.
All of the following issue bonds EXCEPT A. sole proprietorships B. the US government C. municipalities D. corporations
A. sole proprietorships
Corporations, municipalities, and the US government issue bonds. Sole proprietorships assume debt by borrowing from a bank.
Which of the following entities are exempt from the Trust Indenture Act of 1939? I. Any large corporation II. The US government III. Municipalities IV. A corporation issuing a bond for $40 million A. I and II B. I and IV C. II and III D. II and IV
C. II and III
Government at the federal and municipal level are both exempt from the Trust Indenture Act of 1939. The Act applies to corporate bonds issuing for $5 million or more in a 12-month period.
Which of the following are found on a bond certificate?
I. Names of the chief officers of the corporation
II. The corporation’s credit rating
III. Call features, including first call date, if any
IV. Interest rate and payment dates
A. I and II
B. I and III
C. II and IV
D. III and IV
D. III and IV
Bond certificates contain basic information regarding the bond itself, such as the name of the issuing corporation, call features, the coupon rate, and the principal amount of the bond. There is no requirement that the corporation’s officers be named, or that its credit rating be given.
The excess of par over the market price of a bond is called A. the premium B. the discount C. the amount owed D. the overage
B. the discount
If par is greater than (in excess over) the market price of a bond, the bond must be selling at a discount.
Which of the following bonds is considered to be the safest? A. A rated mortgage bond B. Baa rated equipment trust certificate C. AA rated unsecured debenture D. B rated funded debt
C. AA rated unsecured debenture
The safest of the bonds listed is the AA rated unsecured debenture. You don’t need to be concerned with the type of bond; the rating takes into ac- count all features of the security when rating the credit risk.
Under what economic circumstances do issuers call bonds?
Bonds are typically called when interest rates are declining. Consider the issuer’s side: would you want to pay more interest for the use of money than you need to?
Both call risk and reinvestment risk apply to callable bonds.
Investors who purchase callable bonds face what types of investment risk?
Call risk is the risk that the bonds will be called and the investor will lose the stream of income from the bond. Remember that bonds don’t pay interest after they have been called. The call feature also causes reinvestment risk. If interest rates are down when the call takes place, what likelihood does the investor have of reinvesting the principal received at a comparable rate?
Both call risk and reinvestment risk apply to callable bonds.
Which of the following would an investor prefer in a bond she is purchasing?
A. A long call protection period when interest rates are high
B. A long call protection period when interest rates are low
C. A short call protection period when interest rates are high
D. A short call protection period when interest rates are low
A. A long call protection period when interest rates are high
Investors want to lock in the highest possible rate of interest for the longest period of time. During the call protection period the issuer may not call the bonds away.
Account established so that an issuer has the money to redeem its bonds
D. Sinking fund
Contractual promise stating that the bond issue is not callable for a certain period of time
A. Call protection
The schedule of interest and principal payments due on a bond issue
C. Debt service
Difference between the higher price paid for a bond and the bond’s face amount at issue
B. Premium
Which of the following AA rated corporate bonds would be expected to have the market price?
A. A bond with 20 years to maturity when interest rates have risen
B. A bond with 20 years to maturity when interest rates have dropped
C. A bond with 10 years to maturity when interest rates have risen
D. A bond with 10 years to maturity when interest rates have dropped
A. A bond with 20 years to maturity when interest rates have risenMarket prices of existing bonds drop when interest rates rise. The longer the bond has to go to maturity, the greater the effect.
What is the current yield of a 6% bond trading for $800? Current yield (CY) = annual interest ÷ current market price
Solution as follows:
$60 ÷ $800 = 7.5%.
Note that this bond is trading at a discount. When prices fall, yields rise. The current yield (7.5%) is greater than the nominal yield (6%) when bonds are trading at a discount.
What is the current yield of a 6% bond trading for $1,200?
$60 ÷ $1,200 = 5%. This bond is trading at a premium. Price is up, so the yield is down. The current yield (5%) is less than the nominal yield (6%) when bonds are trading at a premium.
YTM is greater than coupon.
Discount
CY is less than coupon.
Premium
YTM is greater than CY.
Discount
YTM is equal to nominal.
Par
