Chapter 1 Flashcards
A new bond issue will include warrants to:
Increase attractiveness of the issue to the public.
By including warrants with debt issues, issuers increase marketability of bonds. Warrants offer long-term opportunity to buy the underlying stock at a fixed price. In addition to increasing marketability, the issuer can offer the bonds with a lower coupon rate and as a result, reduce fixed costs.
All other factors equal, an investor would expect which type of preferred stock to pay the highest stated dividend rate?
Callable.
Ex-date for NYSE-listed issues is set by:
The NYSE
Ex-date is set by the market where the security principally trades.
A change in earnings would affect the price of which of the following securities the most?
- treasury stock
- common stock
- 10% debentures maturing in 10 years
- 6% preferred stock
10% debentures maturing in 10 years.
Common stock is most sensitive to earnings changes because, as owners, common shareholders have a claim on the earnings of the firm.
Advantages of REITs
Liquidity
Diversification
Professional Management
REIT is a professionally managed company that invests in diversified portfolio of real estate holdings. They are traded on exchanges and OTC, which provides liquidity. IRS does not permit tax deferrals on REIT investments.
A stockholder owns 200 shares of common stock in a corporation that features statutory voting. If an election is being held in which 6 candidates are running for 3 seats, the stockholder could cast the votes:
200 for each of the 3 directors.
Stockholder has one vote per seat for each share he owns. Under statutory voting, he must allocate an equal number to each seat.
New Offering: 800,000 units at $6 per unit. Each unit has 2 shares of common stock and 1 warrant. Each warrant is to purchase 1/2 share of common stock. How many shares of stock will be sold and how many warrants?
1.6 million shares and 800,000 warrants.
Warrants can be distributed to stockholders in an underwriting as part of a unit. As a form of bonus to entice investors to purchase the unit.
A company set up to invest in real estate, mortgages, construction and development loans that must distribute at least 90% of its net income to avoid paying taxes on the income distributed is called:
a Real Estate Investment Trust (REIT)
A convertible preferred stock issue (par value $100) is selling at $125 and is convertible into 5 shares of common stock. Conversion price of common stock is:
20
Par value divided by conversion price equals the number of shares into which the security is convertible. If this security is convertible into 5 shares we need to know what number goes into $100 5 times.
Advantages of investing in ADRs (American Depositary Receipts)
ADRs fall under oversight of the SEC
Transactions are done in US currency
Dividends are received in US currency
Terms applicable to REITs
Dividends taxed at full ordinary income rates
Managed
Secondary Market
REITs trade in the secondary market and are not redeemable. They are actively managed, and dividends do not meet the requirements to be taxed as qualified dividends, so they are taxed as ordinary income.
a client who seeks diversification through real estate is concerned about illiquidity associated with investing in real estate, which of the following investments is most suitable?
- privately placed investment
- interest in a real estate limited partnership
- Real estate investment trust
- direct investment in a shopping center renting space
REIT - Real Estate Investment Trust
Market traded securities that provide an investor with a liquid market in which to invest in real estate.
Which of the following is an equity security?
- REIT share
- mortgage secured bond
- GNMA pass-through certificate
- collateralized mortgage obligation
REIT share
Equity security that represents undivided ownership in a portfolio of real estate investments.
Last day that stocks can be bought for cash and still receive the dividend is:
The Record Date
Cash trade settles the same day.
ADRs
Issued by large domestic commercial banks to facilitate US investors who want to trade in foreign securities.
Common stock of ABC currently earns $3 per share. If price-to-earnings ratio for this stock is 14, what is the current market price?
42
Price-to-earnings ratio equals the market price divided by the earnings per share. (14 x $3 = $42)
Feature of preferred stock that allows the holder to reduce the risk of inflation:
Convertible.
Fixed dollar investments such as bonds and preferred stock are subject to inflation risk, which is the risk that the fixed interest or dividend payments will be worth less over time in terms of purchasing power. The ability to convert to common stock, which tends to keep pace with inflation, offsets this risk.
A company that has issued cumulative preferred stock:
pays past and current preferred dividends before paying dividends on common stock.
Bond interest is always paid before dividends. Dividends in arrears have the highest priority of dividends to be paid.
If a corporation attaches warrants to a new issue of debt securities, a resulting benefit to the corporation would be:
Reduction of debt securities interest rate.
In general, a corporation assumes the LEAST risk when it obtains funds from:
Sale of preferred stock.
Sale of preferred stock does not entail the assumption of debt and therefore is the least risky. It is ALWAYS riskier to borrow than to raise equity because equity does not have to be paid back.
Which of the following statements regarding the effects of a stock dividend is TRUE?
- capital surplus is reduced
- net current assets are decreased
- market value of stock is decreased
- new capital is channeled to the company
Market Value of the stock is DECREASED.
A stock dividend results in an increased number of outstanding shares, each with a lower value per share. Total value of outstanding stock is unchanged. There is no new capital generated from a stock dividend. Current assets are unchanged because there is no increase or decrease to the company’s cash as a result of the stock dividend.
Cash dividends from REITs are:
Taxed as ordinary income.
ADRs are used to facilitate the:
Domestic trading of foreign securities.
ADR is a negotiable security that represents ownership interest in a non-US company. Because they trade in the US marketplace, they allow investors convenient access to foreign securities.
ABCs stock has paid a regular dividend ever quarter for the last several years. If the price of the stock has remained the same over the past year, but the dividend amount per share has increased, it may be concluded that ABCs:
Current Yield per share has increased.
Current yield is income (dividend) divided by price. A higher dividend divided by the same price results in a higher yield. Stocks do not have a Yield to Maturity.
A customer owns cumulative preferred stock (par value of $100) that pays an 8% dividend. The dividend has not been paid this year or for the 2 previous years. How much must the company pay the customer per share before it may pay dividends to the common stockholders?
24.
If the company is going to pay common stock dividend, it must pay preferred dividends first. Cumulative preferred must also receive all dividends in arrears.
While looking at a stock listing in the financial section of your local newspaper, you notice that the dividend is indicated by the notation “.15q” If you owned 1000 shares, you could anticipate annual dividends of:
600.
The notation .15q indicates a quarterly dividend of $.15. Therefore, the annual dividend is $.60 per share.
1000 shares x .60 = $600
If Flying Horse Corp splits 5:4, the presplit $.40 par value of the common stock would be adjusted to:
0.32.
Stock splits would change the par value of the stock, To calculate the new value, multiply the original par by the inverse split: 4/5 x $.40 = $.32
Which of the following securities typically carries the highest dividend rate?
- straight preferred
- convertible preferred
- participating preferred
- callable preferred
Callable Preferred.
Straight preferred is the benchmark rate. Compare to straight preferred, both convertible and participating preferred tent to carry lower dividend rates, as the investor has been given something extra in the right to convert to common at a fixed price or the right to earn more than the stated rate if the BOD elects to make an additional dividend payment. Callable preferred allows the issuer to call the securities away from the investor. From an investing point of view, this is not an incentive. Therefore callable preferred tends to pay higher rates.
All of the following are true of REITs EXCEPT:
- they must pass along losses to shareholders
- shares are publicly traded
- they must invest at least 75% of their assets in real estate related activities
- they must to qualify under Subchapter M, distribute at least 90% of their net investment income
they must pass along losses to shareholders.
REITs engage in real estate activities and can qualify for favorable tax treatment if they pass through at least 90% of their net investment income to shareholders. While they can pass through income, they cannot pass through any losses.
GHI stock is at $10 par value and is selling in the market for $60 per share. If the current quarterly dividend is $1, the current yield is:
6.7%
Current yield is determined by dividing the annual dividend of $4 ($1 per quarter x 4 = $4) by the current stock price of $60 ($4 / $60 = 6.7%)
the issuer of an ADR is a:
Foreign branch of a domestic bank.
Everything is in English and in US dollars.
Shareholder approval is required for:
- issuance of convertible bonds.
- acceptance of a tender offer from a non-affiliated company.
- stock splits
Shareholder approval is NOT required for the payment of dividends.
If a stocks ex-dividend date is Tuesday, January 13, when is the record date?
Thursday, January 15.
The record date is TWO BUSINESS DAYS after the ex-dividend date.
Which of the following represent ownership in a corporation?
- debentures
- convertible bonds
- preferred stock
- common stock
Preferred Stock and Common Stock.
A company has reverse-split its common stock. The effect on the earnings per share will be:
An Increase.
When a reverse split takes place, the number of outstanding shares is reduced. Since the split has no effect on earnings of the company, dividing those earnings by fewer shares will cause an increase to the earnings per share.
A company’s dividend on its common stock is determined by:
Its Board of Directors.
Which of the following statements regarding warrants are TRUE?
- they pay dividends
- represent ownership in the issuing corporation
- allow for purchase of common stock at fixed price
- they do not give holders voting rights
They allow for the purchase of common stock at a fixed price, and they DO NOT give holders voting rights.
Holders of warrants have the right to buy stock from the issuer at a stated price for a specific time period. They do not pay dividends which are only paid to stockholders, nor do they give voting rights. The holder of the warrant does not own the stock until the warrant is exercised.
Treasury stock is:
Stock repurchased by the issuer.
Has no voting rights and does not receive dividends.
Treasury stock is not included when calculating shareholders equity or net worth.
Dividends from American Depositary Receipts (ADRs) held by US investors are declared in:
The foreign currency, but paid in US dollars.
*this is one reason why currency risk is a factor for ADR holders.
Which of the following securities carries the greatest amount of risk?
- common stock
- debentures
- corporate bonds
- preferred stock
Common Stock.
Common stockholders are always the last to receive payment in the event of a corporate liquidation and, therefore, have the most risk. However, common stockholders have the greatest potential reward of ownership if the corporation is successful.
ABC, whose common stock is trading at $32, has issued $40 million of 8-1/8% debentures due 10-1-14. Each bond issued with a $1000 PAR value has a warrant attached enabling the holder to buy 4 shares of ABC common at $40 per share. If all the warrants are exercised, ABC will receive:
$6.4 million.
There are a total of 40,000 warrants outstanding ($40 million of debentures / $1000 par value per bond). Each warrant entitles the holder to buy 4 shares of common stock. Therefore, if all warrants are exercised, holders will be purchasing 160,000 shares (4 x 40000) at $40 per share. 160,000 x $40 = $6.4 million.
If ABC declares a 5:4 stock split, an investor who owns 300 shares would receive how many additional shares?
75
a 5:4 split represents a 25% increase in shares. For each 4 shares owned, the investor will receive 1 new share. 1/4 = 25% increase. 300 shares x 25% = 75 shares.
ABC has 5.5 million shares outstanding. They want to raise capital by selling 2 million shares through a rights offering and they engage an underwriter on a standby basis. By the expiration date ABC was only able to sell 1 million shares to existing shareholders. After expiration how many shares are outstanding?
7.5 million.
ABC engaged a standby underwriter who commits to purchase any unsold shares. Therefore regardless of the number of shares initially subscribed to, all 2 million shares will be sold.
ABC has 1 million shares of common stock outstanding ($10 par value) paid in surplus of $10 million and retained earnings of $10 million. If ABC stock is trading at $20 per share, what would be the effect of a 2:1 stock split?
The par value would decrease to $5 per share.
A stock split results in more outstanding shares at a lower par value per share. The total value of stock outstanding is unchanged. Retained earnings are not effected by a stock split.
Preferred Stock :
- dividend is fixed except in case of adjustable preferred
- preferred stock has no set maturity date
- because there is no set maturity value or redemption date, the holder of preferred stock has to sell his shares in the open market to close out his position.
- preferred stock does not generally have voting rights
If a common stock is currently selling for $75 per share with quarterly dividend of $.75 the current yield is:
4%
Current Yield formula = Annual Yield divided by Current Price. Ex ($.75 x 4) / $75 = 4%
Registrar Functions
Accounts for the number of shares and audits the transfer agent.
Common Stockholders rights and priviledges:
- right to vote on important affairs in the life of the company
- NO rights to vote on routine operational decisions. NO promise is offered with regard to stockholders initial investment, which might be lost, or dividends, which might not be declared.
ABC, a publicly held company, decides to issue shares in an additional public offering. If the APO is for an additional 1 million shares and 60% of shares are subscribed to in the preemptive rights offering, how many shares will the standby underwriter for this offering have available to sell to the public?
400,000.
If 60% of the additional shares are already subscribed to by existing shareholders, then 40% of the additional shares will be sold to the public through a standby (firm commitment) underwriting (1,000,000 x 40% = 400,000)
In a 3-for-2 stock split an investor will:
have 50% more shares at 2/3 the price.
If a stock splits 3 for 2, an investor will receive an additional 50 shares for every 100 shares owned. The price will decline by 1/3, but the total value of the position will stay the same.
your client owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date what will he own?
125 shares at a cost of $20 per share.
Stock dividends make the number of shares owned increase and the cost per share decrease. The overall value should remain unchanged before and after the adjustment.
Which of the following taxes does NOT impact the holder of an ADR?
- federal income tax
- state income tax
- foreign income tax
- excise tax
Excise Tax.
Dividends on ADRs are subject to both federal and state income tax. In addition, the country of origin will frequently levy a tax which may be used as a credit on the investors federal income tax return.