Chapter 1, Day 1 Flashcards
What is the definition of a security?
A security is any investment product that can be exchanged for value and involves risk. It must be readily transferable between parties and subject the owner to potential loss of principal. If it lacks transferability or risk, it is not a security.
Name at least three examples of securities and nonsecurities.
Securities: Common stock, mutual funds, options
Nonsecurities: Whole life insurance, IRAs, confirmations
What is equity in the context of investments?
Equity is synonymous with stock and represents ownership in a corporation. Investors who purchase stock own part of the company.
Why is equity considered perpetual?
Equity has no maturity date, meaning investors may hold shares indefinitely until they choose to sell.
What types of stock must a company issue first?
A company must issue common stock before issuing any other type of equity security, such as preferred stock.
Define authorized stock.
Authorized stock is the maximum number of shares a corporation is legally allowed to sell, as determined at incorporation. Selling beyond this number requires shareholder approval.
What is issued stock?
Issued stock is authorized stock that has actually been sold to the public. It always counts as issued, even if repurchased by the company later.
Why might a company issue additional authorized shares?
To pay dividends, expand operations, exchange for convertible securities, or fulfill obligations under employee stock options.
Define outstanding stock.
Outstanding stock refers to shares that have been sold to investors and remain in their hands (i.e., not repurchased by the company).
What is treasury stock and how is it used?
Treasury stock is stock that has been sold but then repurchased by the company. It does not receive dividends or vote. Companies may use it to maintain control, increase EPS, fund employee plans, or for mergers/acquisitions.
What is the formula for calculating treasury stock?
Issued stock − Outstanding stock = Treasury stock
How is the market value of common stock determined?
By supply and demand, often influenced by current and future expectations, not necessarily the company’s actual worth.
What is book value, and how is it calculated per share?
Book value is the company’s theoretical liquidation value (assets minus liabilities).
Book value per share = Total book value ÷ Outstanding common shares
What is par value, and why is it not important to investors?
Par value is the nominal value set by the company for accounting. It has no relation to actual market value and is only relevant for balance sheet purposes.
What are preemptive rights, and what are the possible outcomes?
Preemptive rights let shareholders maintain their ownership percentage by buying new shares before the public.
Three outcomes:
Exercised – investor buys new shares
Sold – rights are sold to another investor
Expire – rights lapse if unused after 45 days
