Chapter 1- Equity securities 10-15 questions Flashcards
What two sides are the investment world divided into?
Owners (stock or equity) and Lenders (Bonds or Debt)
What is a security?
An investment that represents either ownership stake or a debt stake in a company.
Debt Security
Acquired by purchasing a company’s bonds.
Debt Investment
Loan to a company in exchange for interest income and the promise to repay the loan at a future maturity date.
DOES NOT CONFER OWNERSHIP
Stock Exchange
Auction market where buyers and sellers are matched by a specialist (Designated Market Maker) who maintains a fair and orderly market for a particular set of stocks.
Example: New York Stock Exchange
Over the counter market
Normal place for a stock and bond to be sold
Interdealer market linked by computer terminals to FINRA member firms across the country. No physical location, all done online.
Stocks vs Bonds
Stock represents equity/ownership
Bonds are a loan to a company
A company discloses the composition of its total capitalization (equity and debt) on Balance sheet
Balance Sheet
Summarizes company’s
Assets- what the company owns (includes property, inventory etc)
Liabilities- what company owes, accounts payable (current bills)
Equity- Excess of value of assets over value of liabilities (company net worth)
Net Worth
Assets - Liabilities = Net worth
Assets= Net Worth - Liabilities
Stockholders
Stockholders have purchased a share of ownership in the company’s net worth
Being a stockholder entitled you to company profits and dividends and an equal vote
Select Board of Directors, which allows them to have some say in company management, but not day to say activities
Preferred Stock
Normally pays a fixed, semiannual dividend and has priority claim over common stock
Does not usually have same boring rights or appreciation potential
Authorized Stock
Specific number of shares available to issue or sell
Laid out in the company’s original charter
Charter is amended through stockholder vote if company decides to sell more
Issued Stock
Has been authorized and distributed to investors at some point
A partial amount of initial authorized stock is usually left unissued for future fund raising, stock dividend, employee stock purchase plans, convertible bonds and stock purchase warrants
Unissued is not considered in total cap
Outstanding stock
Any shares issued and not repurchased by the company
Treasury stock
Issued stock that has been repurchased by the company from the public.
Can be held, reissued or retired
Does not carry voting rights or the right to receive dividends
Reasons why a company would buy back stock
Increase EPS (should increase as long as operating income remains the same)
Inventory to distribute a stock option, fund a pension plan and so on
Or to use for further acquisition (funding)
Par value
Meaningless figure
Arbitrary figure company gives the stock in company’s articles of incorporation and has no effect on the market price
Paid in capital
Money received exceeding the par value recorded
Book Value
How much a stockholder should expect to receive if company was liquidated
(Tangible assets -liabilities) / shares outstanding
Usually is different from market value
Market Value
Most common sign of market value is the market price
Influenced by a company’s business prospects and the consequent effect on supply and demand
Good future earnings possibility means demand will rise the price above book value
Most meaningful to investor
Common stockholder voting rights
Able to elect Board of Ds
Vote on policies such as:
Issuance of convertible securities or additional common stock
Substantial changes of the business, such as mergers and acquisitions
Declarations of stock splits
DO NOT VOTE ON DIVIDENDS
Statutory Voting
One vote per share owned for each item on ballot
Board candidate only needs a simple majority
Cumulative voting
Stockholders can allocate in any manner they choose
Benefits the smaller stockholder
Proxy Voting
Form of absentee voting for those who cannot attend annual meeting
Can be cancelled if a stockholder attends the meeting, authorizes a different proxy or does
Companies send Proxies out in a proxy solicitation. Exact details on the vote must be provided and reviewed by SEC.
Proxy Contest
Proxy where control in the company could change
All persons involved must register with SEC
Includes people who give UNSOLICITED advice
Non voting common stock
May be issued but not in same class as voting common shares
Usually called class b
Antidilution Provision
Requires a company to offer those who own stock a chance to buy newly issued shares
Also referred to as the stockholders preemptive right to purchase enough shares to maintain same ownership control
Inspection Rights
Ability to receive annul financial statements and lists of stockholders.
Forward Stock Split
Increases number of shares, reduces price per share on market while maintaining an investors market value
Total market value before and after split is the same
To find new amount of shares in a 5:4 split:
100 x 5 = 500 / 4 = 125 (new share amount)
Percentage decrease in price will always be less than the percent increase in shares
In a 2:1, shares increase by 100% but price is decreased by 50%
Reverse Split
Investors own fewer shares but they are worth more
Price will always increase faster than shares decrease in this case
Written 1:2, 1:3 etc
Increases eps and market value
Long position
Purchasing shares with intent of selling at higher cost
Bull
Short position
Borrowing shares to sell now with intent of buying back at a lower price
Bear
Capital Appreciation
When the market price for shares increase
Income
Usually takes shape in a cash dividend, stock dividend or property dividends (shares in a subsidiary or product)
Company’s looking to reinvest earnings usually issue stock dividends
Dividend taxation
Generally are taxed at income rate
Corporations get a 70% exclusion for dividends paid to them
Market Risk
Chance that a stock will decline in price at a time the investor needs his money
Short investor has unlimited market risk
Senior Securities
Company debt and preferred shares
Common stock are junior securities
Is preferred stock an equity or debt security?
Both.
Equity because it represents ownership in the corporation
Debt because it is usually issued as a fixed income security with a fixed dividend. (Receives dividend first)
Usually moves with interest rates in value rather than business prospectus. Mostly no voting.
Preferred stocks fixed dividend
Par Value is almost always $100
Usually, preferred stock is Id’d by its dividend rate
Payment has to be approved by BOD and is not guaranteed
Adjustable-Rate Preferred
Preferred stock issued with an adjustable interest rate.
Usually tied to a benchmark rate such as tbills and money market rates
Reset Date- Date when a dividend is reset
Preferred stock features
Very rare to be able to vote
No maturity date is usually set
Fluctuates in price more like a debt instrument
Interest rates fall with price rises (inverse relationship, happens in bonds too)
Straight preferred
No special features outside of dividend
Missed dividends are not paid to holder
Cumulative preferred
Brings in arrearages
If company does not pay dividend in one period, it will pay it later
Convertible preferred
Ability to exchange preferred for common
Preset amount at which the stock can be converted
Price fluctuates with common price due to the conversion possibility
Usually lower stated dividend
Participating preferred
Participates in profits of a company at a specific percentage in addition to fixed dividends
Written: XYZ 6% preferred participating 9%
Additional 3% dividend is possible in good years
Callable preferred
Company can buy back the preferred stock at a specified date and price.
Dividends and conversion rights generally cease on call date.
Higher dividend is paid during time period
Company usually pays a premium for the privilege to call
Dividends
Distributions of a company’s profits to its stockholders
Issued by the BOD
Cash dividends are usually distributed by check or put auto into brokerage account if still in street name (brokerage firms name
Stock dividends are not usually paid by growth company’s as they look to retain their earnings to feed growth. Market price declines and total market value holds NOT TAXABLE CHANGES COST BASIS OF SHARES TO AN AVERAGE OF REMAINING SHARES AND DOLLAR AMOUNT
Current Yield
Current (dividend) Yield= Annual dividend / current market value
REMEMBER TO USE ANNUAL DIVIDEND
Round vs odd lot
Round = divisible by 100
Odd = fewer than 100 shares
Unless value is $175 plus, in which there are no odd lots
CUSIP
Committee on Uniform Securities Id procedures
On common, preferred, corporate bond, and municipal bonds
Used in trade confirmations
Stock Power
Form that simulates the signing over of a security
Member firm or commercial bank must authenticate
Stocks can be transferred, assigned, or sold
Transfer Agent Role
Ensures it’s issued in correct name
Cancel old and issue new certificates
Maintain ownership record
Handling problems
Also distributed new shares in stock split
Registrar
Registrars are independent and issue new securities
Must make sure there are not more issues stocks than authorized
PE Ratio
Ratio of stocks current price to its most recent 12 month earnings per share
High and Low
High and low price is reported for the day
Nasdaq
Over the counter stocks that have both national and global interest are traded on the NASDAQ
Three different tiers
- Nasdaq Global Select (stringiest in regards to both financial and liquidity)
- Nasdaq global Market (Largest of three tiers, high interest and appeal stocks)
- Nasdaq Capital Market (SmallCap Market)
Dividend Disbursing Process
When a BOD approves a dividend payment, it also sets the payment date and dividend record date.
Must notify FINRA at least 10 business days before record date
Ex-date is usually posted by FINRA or the exchange 2 business days before record date
Buyer not considered owner until settlement date for dividends only
Payable Date- when the dividend disbursing agent send out dividend to those on record, 3 to 4 weeks after
Cash trades settle on the same day so they go exdividend the day after the record date
DERP (tip for dividends)
Declaration
Ex
Record
Payable
DRP is determined by company
Stock Dividends and Splits
25% or more distribution requires special handling
Ex date for 25% or more and 5for 4 or better is first business day following payable date
Due Bill
If a settlment lasts longer, send due bill to get the dividend from seller
Preemptive rights and Rights offering
Preemptive right is ability to maintain proportional ownership
Rights offering allows investors to buy stock at below market price or sell their rights to buy for a gain (valued separate)
One right is issued for each common stock share outstanding, may take multiple rights to purchase a share
Record date for a rights offering is 30 days after declaration. Will usually have a 30-45 day window to purchase shares
Value of a right formula
Market price - subscription price / number of rights to purchase 1 share + 1
Market price= 41
Subscription per share= 30
Number of rights to purchase 1 share= 10
41-30/11 = $1 value of right
If asked cum rights must add the one, if ex then find value by doing without 1
Standby by underwriting
If all shares do not sell then an investment banker will buy on a firm commitment basis, and sell them to public
Warrant
Certificate that grants an opportunity to buy securities from issuer at a specific price at later date
Usually have a life of two to five years
Usually attached as sweetener to make preferred stock and bonds more attractive, can be sold separately
American depository receipts
Facilitate trading of foreign stocks in US Market
Between 1-10 shares per receipt
Foreign branches of US banks issue, a custodian (foreign bank) holds the securities represented
Generally do not have voting rights, but receive dividends
Currency risk is taken on in addition to other market risk when investing in ADRs
Exchange listed ADRs are sponsored
Subject to foreign withholding tax that can be netted against US tax
REIT
Reits are organized as trusts where investors buy shares
REITs must have at least 75% of assets in real estate, 75% of income from rent or mortgages and distribute 90% of net investment income to shareholders
Equity REIT vs Mortgage REIT
ER- Own property
MR- Own mortgages on property
Hybrids hold both
Why trade in REITs?
Lowers liquidity risk associated with real estate
Historically, real estate prices have had a negative correlation to stock prices. Providing a hedge to the market
Reasonable expectations of income
Formula for calculating rights
CMV - subscription / number of rights to purchase +1
Note on ADRs
Foreign governments commonly charge income tax to a foreign security
What is the formula to find the price of a right?
Market price - subscription
/
Number of rights required to buy +1
Before exdate
After exdate
Market price - subscription price
/
Number of righte
A corporation assumes the least risk when obtaining funds
Through a sale of preferred stock
What is a warrant
A warrant grants its owner the right to purchase shares at a later date for a specific price
Usually offered as a sweetener in connection with other securities
Have a life of five years
Which bank issued an ADR
Foreign branch of a domestic bank
OTC round lot
1 round lot on the OTC is equal to 1 share if price is over $175
Registrars are not in charge of
Cancelling old shares or transfering shares into the new owners name
REITs do not flow through their
Losses
Which preferred stock allows the holder to reduce risk of inflation
Convertible
Basis point
.01% or .0001 per $1
