C1 Equity Securties

Question 1

Definition of a Security

Answer 1

A security is any investment product that can be exchanged for value and involves risk. Key concept is transferable and risk. If there is no possibility of losing money, it is not a security.

Following are securities:

Common stocks

preferred stocks

Bonds

Mutual Funds

Variable Annuity

Following are not securities:

Whole Life Insurance

Term life Insurance

IRAs (account not a security)

Retirement Plan (plan not an actual security)

Fixed Annuity (no risk)

Question 2

Equity

Answer 2

Equity = Stock….the two terms are interchangeable.

Equity/Stock creates an ownership in the issuing company. You own part of the company.

Equity is perpetual….there is no time limit.

Question 3

Common Stock

Answer 3

All publicly traded companies must issue common stock before any other type.

Question 4

Common Stock Issuing

Answer 4

Authorized Stock - When company is incorporated, they decide on how many shares of stock they want to issue. The number of shares is arbitrary. If a company wants to issue more than authorized shareholders must vote and approve it.

Issued Stock - Issued stock is stock that was actually sold to the public. Usually companies will not issue all the authorized stock initially, and will hold some for later transactions. Once shared are issued to public they will always be counted as issued, even if they are repurchased by the company.

Outstanding Stock - Stock that was sold to the public, and actually still remains in the hands of the investing public. Treasury Stock - Stock that was issued to the public and later repurchased back by the company.

Issued Stock - Outstanding Stock = Treasury Stock

Issued Stock - Treasury Stock = Outstanding Stock

Question 5

Reasons a company might repurchase stock

Answer 5

1. To maintain control of the company
2. To increase earnings per share
3. To fund an employee stock purchase plan
4. To use shares to pay for a merger or acquisition.

Question 6

Values of Common Stock

Answer 6

Book Value - The theoretical value of the company. Found by taking the tangible (real) assets and subtracting the liabilities.

Par Value - usually $1.00. Only useful for calculations in the Balance Sheet. Has no bearing on actual value.

Question 7

Rights of COMMON Stockholders

Answer 7

Preemptive Rights - Maintain your current percentage Interest in the company when new shares are used. You have the right to buy enough shares to maintain your percent ownership.

Voting Rights - Common stockholders have the right to vote on the major issues facing the company.

Limited Liability - A stockholders is limited to the amount of money that has been invested. They cannot be held liable for any amount past their investment

Freely Transferable - Investor can sell the shares at any tine to any another investor without restrictions

Inspection of Books and records – all stockholders have the right s to inspect the company’s books and records. They can also get a list of all stockholders.

Residual Claim to assets – in the event of bankruptcy, common stockholders have the right to receive their proportional interest in residual assets. Common stockholder are on the bottom of the list when it comes to getting paid in a bankruptcy. Most junior security.

Question 8

Rights Offering

Answer 8

When a company decides to issue more stock. The existing shareholders have the right to purchase the new shares at a discount (Called the Subscription Price) to the current market for up to 45 days. For each share a stockholder owns they get 1 right.

Usually it will require multiple rights to purchase a single new share.

Question 9

Possible Outcome for a Right

Answer 9

1) Exercised - The investor decides to buy the new stock.

2) Sold - The right has value, and the investor can sell it.

3) Expire - The rights expires if not exercised or sold within the the 45 days. This happens when the market price of the stock has fallen below the subscription price.

Question 10

Cum Rights - Ex Rights

Answer 10

When the rights offering is declared, the stock trades with the value of the rights included (CUM rights).

When the EX date occurs, the stock no longer has the value of the rights included (Ex Rights).

Question 11

Cum Rights Value Formula

Answer 11

Question 12

Ex Rights Value Formula

Answer 12

Question 13

Stock Splits

Answer 13

A company may decide to change the share price and the number of outstanding shares. It can do this with a forward or reverse stock split. In all cases the overall market capitalization stays the same

Forward – EX. 2:1 The stock price decreases and the number of shares increase. This is often done to make he stock more affordable to individual investors

Reverse- EX. 1:2 The stock price goes up, and the number of shares decrease. This is often done to make it more attractive to institutional buyers who often can’t purchase stock with very low prices.

Question 14

Voting

Answer 14

Common stockholders have the right to vote on the major issues facing the corporation. Biggest emphasis is placed on the election of the Board of Directors.

They also vote on:

• Issuance of bonds or additional common shares
• Stock Splits
• Mergers and Acquisitions
• Major Changes in Corporate policy

They do not vote on:

• Executive compensation
• Bankruptcy

Question 15

Methods of Voting

Answer 15

Common shareholders cast 1 vote for each share of stock they own. For Board of Directors votes they receive 1 vote for each open position. For example, an investor with 100 shares would get 100 votes for each open position. If there are two open positions they would get a total of 200 votes. Depending on the type of voting authorized they can vote differently.

Statutory – Requires that the votes be distributed evenly among the candidates the investor wishes to vote for. (IE in this case 100 for each candidate)

Cumulative – allows shareholders to cast all their votes in favor of one candidate. (IE 200 votes for a single candidate. Cumulative voting is said to favor small investors.

Question 16

Transfering (Selling) Stock

Answer 16

Stock Certificate proves ownership of the stock.

The certificate identifies:

• The name of the issuing company
• The number of shares owned
• The name of the owner of record
• The CUSIP number.

To transfer the stock to another owner, the current owner endorses the stock certificate or sign a power of substitution known as a stock or bond power.

Question 17

Transfer Agent

Answer 17

The transfer agent is the company that is in charge of transferring the record of ownership from one party to another.

The transfer agent does the following:

• Cancels old certificates registered to the seller
• Issue new certificates to the buyer
• Maintains and records a list of stockholders
• Ensures that shares are issued to the correct owner
• Locates lost or stolen certificates
• Issues new certificates in the event of destruction
• May authenticate a mutilated certificate.

Question 18

The Registar

Answer 18

The registrar is the company responsible for auditing the transfer agent to ensure the transfer agent does not erroneously issue more shares than authorized.

Question 19

CUSIP Number

Answer 19

The Committee on Uniform Securities Identification Procedures issues CUSIP numbers which are printed on the stock or bond certificates to help identify the security. CUSIP numbers must also appear on trade confirmations.

Question 20

Benefits and Risks of Common Stock Ownership

Answer 20

People buy common stock in hopes of capital appreciation. The value of the stock goes up and they realize a profit. They also buy certain common stocks because they receive income (dividends).

The risks include loss of capital if the stock price decreases, the dividends are not guaranteed and can be stopped, and the common stock is the most junior security in bankruptcy claims.

Question 21

Dividend Yield Equation

Answer 21

Common stock dividends are paid quarterly. The equivalent yield is calculated as follows:

Yield = Annual Income / Curent Stock Price

or

Yield = (Quarterly dividend * 4) / Curent Stock Price

Question 22

“Regular Way” Timeline for Stock Trades

Answer 22

Trade Date (T) – the trade date is the date your order is actually executed.

Settlement Date (T +3) – The buyer of a security actually becomes the owner on the settlement date. The seller’s name is removed from the security and the buyer’s name is recorded as the new owner. The Settlement date is 3 days after the trade date.

Payment Date (T+4) – The payment date is the day when the buyer of the security has to have the money to the brokerage firm to pay for the purchase. Payment dates are regulated by the Federal Reserve Board under Regulation T of the Securities Exchange Act of 1934.

!!!Prior to September 5, 2017 this was 5 days not 4!!!

Violation – If the customer fails to pay for the purchase within 4 business days, the brokerage firms will “sell out” and freeze the customer account. On the fifth day (T+5) they will sell the securities that the customer failed to pay for and freeze his account for 90 days. A frozen account means that the customer has to deposit the money for any transaction ahead of time.

Question 23

Preferred Stock

Answer 23

Preferred stock is an equity security with a fixed income component. Like a common stockholder, the preferred stockholder is an owner of the company. The preferred stockholder is investing in the company for the fixed income that preferred shares generate through semiannual (twice a year) dividends. Preferred stock has a fixed, stated dividend rate that the company must pay. Growth (capital appreciation) through raising stock prices is generally not achieved through investing in preferred shares.

Question 24

Features of Preferred Stock

Answer 24

Par Value – Par Value of preferred stock is important, unlike common stock. The Par Value is usually $100. This is used for the dividend payment (IE. (9 % preferred -> $90 a year in income (9% * 100)

• Payment of Dividends – Preferred shares are paid their dividend before common stock dividends can be paid. Priority Claim
• Distribution of assets - Preferred stock is also priority over common stock in terms of distribution of assets in a bankruptcy
• Perpetual – Preferred stock, unlike bonds has no maturity date. Investors can hold for as long as they like, unless they are “called”
• Nonvoting – Most preferred stock is nonvoting.
• Interest Rate Sensitive. Because they have fixed income, the price of preferred stock is tied to interest rates

Question 25

Types of Preferred Stock

Answer 25

Straight/Noncumulative – Straight forward with no additional features. If the company cannot pay the dividend it is not owed to the shareholder.

Cumulative Preferred – If the company misses dividend payments, the amounts cumulate, and need to be paid to the referred shareholder before any common dividends are paid.

Participating Preferred – Holders of participating preferred get both the fixed preferred dividends and any dividends paid to common shareholders. They participate in the common dividends.

Convertible Preferred. - Convertible preferred stock can be converted to common shares at a predetermined conversion price.

Callable Preferred – This feature benefits the company not the shareholder. The preferred shares can be called in and purchased by the company. This will often happen when interest rates drop, and the yield on the preferred stock is higher than the market rates.

Adjustable Rate Preferred – Instead of having a fixed dividend rate, they have a payment that is tied to a benchmark (like Fed Rate) interest rate and the rate will vary

Since it has features that benefit the company and not the investor, callable Preferred Stock usually has the highest dividends rates to compensate for the fact that it can be recalled.

Question 26

Types of Dividends

Answer 26

Dividends are usually paid in cash, but other options exist.

• Stock – A company gives shareholders additional stock as a dividend instead of cash
• Property/Product – A company can also give a shareholder product samples to customers as a dividend

Question 27

Dividend Timeline

Answer 27

Declaration Date – The declaration date is the date the Board of Directors decides to pay a dividend to common shareholders of record. This is the starting point. The company must notify FINRA or the exchange at least 10 days prior to the record date

EX-Dividend Date – The Ex dividend date is the first day when purchasers of the stock are no longer entitled to receive the dividend. This is set by FINRA or the Exchange based on the Record Date. It is set 1 day prior to the record date. (This used to be two days prior to Sep 5, 2017)

Record Date – This is the day when investors have to have their name on the stock certificate in order to receive the dividend. It is set by the Board of Directors.

Payment Date – This is the day when the corporation distributes the dividend. This is usually four weeks following the record date. It is set by the Board of Directors.

Question 28

Taxation of Dividends

Answer 28

Ordinary Income Earners – Taxed at 15 %

High Income Earners – Taxed at 20 %

Question 29

“Selling Dividends”

Answer 29

Selling Dividends is a violation. A registered representative may not use the pending dividend payment as the sole basis for his recommendation to purchase a stock. Also cannot use the upcoming divided to create urgency to buy quickly.

Question 30

Warrants

Answer 30

A warrant is a security that gives the holder the opportunity to purchase common stock. 1 warrant is for 1 share of common stock. Like a right it has a subscription price, However the subscription price of a warrant when it is issued is always over current market price.

Warrant has much longer life than a right. Up to ten years. This is why the price is higher than the market price.

Question 31

How do you get Warrants

Answer 31

Units – Often companies attach warrants to IPOs to make the IPO more attractive. A common share that comes with a warrant attached is called a unit.

Attached to Bonds - Often companies attach warrants to Bonds to make the Bonds more attractive. This will help lower the bond yield and the cost of borrowing to the company.

Secondary Market – Warrants have value and are sold on the secondary markets.

Question 32

American Depositary Receipts (ADRs)

Answer 32

An ADR is a receipt that represents the ownership of foreign shares that are being held abroad in a branch of a US bank. Each ADR represents ownership of between 1 and 10 shares of the foreign stock.

The holder of the ADR:

• May Request delivery of foreign shares
• Has voting rights
• Receives dividends that the foreign company pays. The dividend is paid in foreign currency, and bank holding the shares converts it to US dollars. This introduces currency risk.

Question 33

Currency Risks of ADRs

Answer 33

Since the dividend is paid in a foreign currency the investor has currency risk. If the currency of the foreign country decline relative to the US dollars, the dividend will decline in US dollars.

Question 34

Real Estate Investment Trusts (REITs)

Answer 34

A REIT is a special type of equity security organized for the specific purpose of buying, developing or managing a portfolio of real estate.

They can also be formed for mortgage financing and are called Mortgage REITs.

REITs are formed like a corporation and trade on exchanges and over the counter.

REITs get special tax treatment (income flows through to investors and is taxed at their rate) if:

• It receives 75% of its income from real estate
• It distributes at least 90% of its taxable income to shareholders

Only income is passed to investors, not gains and losses.

Question 35

Non-Traded REITS

Answer 35

Some REITS do not trade on the market. They lack liquidity and are hard to value.

Fees for investing in non-trading REIT can be as high as 15%

They require special monitoring to ensure the REITs is performing, and the broker dealer must ensure suitability and needs to adjust recommendations based on the performance and stability of the REIT. A valuation of the Non -Traded REIT must be provided to investors within 18 months of the IPO.