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Series 7 > Chapter 1 - Equity Securities > Flashcards

Chapter 1 - Equity Securities Flashcards

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Series 7 Top-off Exam flashcards
1
Q
  • first of several legislative acts passed by Congress to regulate the securities market.
  • requires prospectus and full disclosure filings for all non-exempt new issues of securities (i.e. corporate stock and bond offerings)
  • referred to as the “Paper Act”, because of the volume of paperwork it mandates
A

Securities Act of 1933

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2
Q
  • this act created the SEC
  • known as the “People Act”, it was passed to establish fair and orderly markets for securities exchanges and trading
A

Securities Exchange Act of 1934

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3
Q
  • this act established self-regulatory organizations (SRO’s) to regulate the over-the-counter (OTC) market
  • one well-known SRO is FINRA
A

Maloney Act of 1938

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4
Q
  • created with the passing of the Maloney Act to regulate the OTC market
  • these entities write the rules and regulations to enforce the securities laws written by the SEC
  • broker/dealers are required to join one of these entities to be permitted to charge commissions and mark-ups
  • broker/dealers and their associated persons must follow rules to remain in one of these entities. Member firms and associated persons can be sanctioned for noncompliance
A

Self-Regulatory Organizations

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5
Q
  • a financial instrument that trades for value based on the expectation of profit from the efforts of third-party management
  • must be easily transferable between parties and its owner must be subject to the risk of loss of a portion of or the entire principal
  • issued in two primary forms: stocks and bonds
A

Security

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6
Q
  • buyers become owners of the corporation
  • this type of stock is called the junior security because it is the last to be paid if the corporation is liquidated through bankruptcy
A

Common Stock

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7
Q
  • this financial statement summarizes a company’s assets, liabilities, and shareholders’ equity at a specific point in time
  • allows the investors to see what the company owns and owes, and the amount invested by the shareholders
  • assets are on the left side, liabilities are on the right
  • the items are listed (top to bottom) from most-to-least current
A

Balance Sheet

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8
Q
  • companies commonly assign a par value to stock at issue
  • however, when no-par stock is issued, this term is the value assigned to the no-par stock on the corporation’s balance sheet
A

Stated Value

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9
Q
  • a financial statement that shows a company’s performance over a specific accounting period (i.e. fiscal year)
  • also known as a profit and loss statement
  • allows investors and managers to see whether the business made or lost money during the reported period
A

Income Statement

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10
Q
  • compares operating income to sales
  • this is an indication of management’s ability to generate income from operating the business
  • trends in this statistic are directly tied to management decisions
  • the formula is:

= [( Sales - Cost of Goods Sold - Selling/General/Administrative Costs) / Sales ]

A

Operating Margin

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11
Q
  • compares net income to sales
  • useful tool for analyzing a company’s profitability over time and allows for comparisons with competitors and the industry in general
  • the formula is:

= Net Income (after tax) / Sales

A

Net Profit Margin

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12
Q
  • measures the entity’s liquidity or solvency
  • a positive number indicates that the company has sufficient current assets to pay current debts
  • a negative number indicates that a company is insolvent
  • the formula is:

= Current Assets - Current Liabilities

A

Working Capital

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13
Q
  • another liquidity measure that gauges the entity’s ability to pay current liabilities
  • a number greater than 1 means the company can pay its current obligations with current assets
  • a number less than 1 means that the company has insufficient current assets to meet current liabilities
  • the formula is:

= Current Assets / Current Liabilities

A

Current Ratio

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14
Q
  • this is a strict measurement of the entity’s ability to pay its short-term obligations because it considers only cash and cash equivalents
  • inventory is subtracted from other current assets
  • the formula is:

= [ (Current Assets - Inventory) / Current Liabilities ]

A

Quick (Acid Test) Ratio

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15
Q
  • this ratio measures the portion of total capitalization that is common stockholders’ equity
  • **creditor’s standpoint - high ratio is good because it indicates that the company is not highly leveraged, or deeply in debt
  • some may view this negatively because the company is too conservative to maximize profitability
  • the formula is:

= [ (Par Value of Common + Retained Earnings + Paid-In Capital) / Total Long-Term Capitalization ]

  • Total Long-Term Capitalization = Stockholders’ Equity + Bonds
A

Common Stock Ratio

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16
Q
  • this is the opposite of the stock ratio
  • measures the portion of total capitalization which is in long-term debt, or leverage
  • a lower ratio indicates that the entity uses less leverage which means it operates more conservatively
  • a ratio exceeding 30-40% is concerning
  • the formula is:

= Par Value of Bonds / Total Long-Term Capitalization

A

Bond Ratio

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17
Q
  • measures the portion of earnings available to common stockholders after the preferred stock has received its dividend
  • the formula is:

= [ (Net Income - Preferred Dividend) / Common Shares Outstanding ]

A

Earnings per Common Share

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18
Q
  • measures the earnings available to common if all convertible securities were converted to common stock
  • this measure is strictly theoretical
  • the formula is:

= [ (Net Income + Convertible Bond Interest) / (Outstanding Common Shares + Common Shares Resulting from Conversion) ]

A

Fully Diluted Earnings per Share

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19
Q
  • one of the most commonly referenced ratios by analysts
  • compares the common stock’s price to its share of earnings this year
  • indicates how fairly priced the stock is compared to similar stocks
  • the formula is:

= Market Price / Earnings per Share

A

Price/Earnings Ratio

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20
Q
  • measures the generosity of the board of directors by measuring the portion of earnings which the board chooses to distribute to the shares
  • the remainder of earnings is kept by the board in retained earnings
  • the formula is:

= Annual Dividend / Earnings per Share

A

Dividend Payout Ratio

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21
Q
  • measures the benefit realized by purchasing the stock at current market value
  • the formula is:

= Annual Dividend / Market Stock Price

A

Current Yield

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22
Q
  • this figure is actual cash generated by operations, as opposed to net income reportable to the IRS
  • this figure adds back “non-cash” deductions to net income
  • the formula is:

= Net Income (or Loss) + Current Depreciation + Amortization

A

Cash Flow

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23
Q
  • this ratio measures how quickly inventory is sold
  • a higher number indicates faster speed, more efficient management, and lower inventory loss risk
  • the formula is:

= Cost of Goods Sold / Average Inventory

A

Inventory Turnover Ratio

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24
Q
  • this ratio measures how much of each revenue dollar is net income
  • a higher ratio is better
  • the formula is:

= Net Income / Revenue

A

Profit Ratio

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25
Q
  • this ratio measures how easily the entity can pay interest on its outstanding bonds
  • a higher number for this ratio is better
  • the formula is:

= EBIT / Interest Expense

A

Interest Coverage Ratio

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26
Q
  • this figure is the liquidating value per common stock share
  • the formula is:

= [ (Total Shareholder Equity - Preferred Equity) / Total Outstanding Common Shares ]

A

Book Value per Share

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27
Q
  • measures the return which the corporation achieves on common stockholders’ equity
  • a higher return indicates better management
  • the formula is:

= Net Income After Preferred Dividend / Common Stockholders’ Equity

A

Return on Common Equity

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28
Q
  • comprises a company’s unsold products waiting to be sold, and can include finished products as well as raw materials used to produce the end product
  • shown as a current asset on the balance sheet
  • key component in calculating Cost of Goods Sold (CoGS) and an important driver of profit, total assets and tax liability
  • two main methods of valuing this for a company are: “last-in, first-out” (LIFO) and “first-in, first-out” (FIFO)

– once a method has been chosen it must be used constantly going forward

A

Inventory

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29
Q
  • the gradual reduction of the value of a tangible asset over the useful life of the asset
A

Depreciation

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30
Q
  • the gradual reduction in the value of an intangible asset
A

Amortization

31
Q
  • a reduction in the value of an asset as the result of the physical reduction in the asset, such as natural resources
A

Depletion

32
Q
  • the difference between the price paid for an asset and its market price when the asset is purchased at a price that exceeds its fair market value
A

Goodwill

33
Q
  • focuses on evaluating a company over time, based on key financial metrics to determine the future value of a company
  • heavily dependent on financial statements to assess a company’s financial condition
  • analysts also study company earnings reports, competitive products and services, lines of distribution, suppliers, and industry trends
  • analysts also look at the company within the broader context of the macroeconomic environment and the industry in which they operate
  • a company’s annual report is an important source of information
A

Fundamental Analysis

34
Q
  • it includes a letter to the shareholders from the CEO, followed by a management discussion and analysis along with info about various business segments.
  • there is a summary of primary financial statements

with historical data for several years and quarterly summaries of profit performance for the current fiscal year

  • also includes current financial statements as well as footnotes and material risk disclosures that are key to understanding a company’s investment merit
A

Annual Report

35
Q
  • supplemental and explanatory notes that accompany the financial statements issued by a corporation
  • they provide important details and allow a company to expand upon the info presented in the statements
A

Financial Statement Footnotes

36
Q
  • this disclosure statement is required if the auditor has a concern that there may be a material event that could affect the company or a misstatement that would materially change the company’s financial situation

– please note that auditors are required to express an opinion on the company’s financial statements

A

Material Risk Disclosure Statement

37
Q
  1. Employee back wages
  2. The IRS for payment of any taxes and penalties due
  3. Secured bondholders (mortgages & lien holders that have specific claim to assets)
  4. Unsecured bondholders (debentures); and creditors
  5. Subordinated debentures
  6. Preferred stockholders
  7. Common stockholders
A

Bankruptcy Priority

38
Q
  • this concept pertains to the fact that stockholders do not participate in the day-to-day management of the company and therefore cannot be held personally liable for debts and judgments against the company
  • the maximum amount the stockholders can lose is the price they paid for the stock
A

Limited Liability

39
Q
  • total number of shares authorized in the corporate charter
A

Authorized Shares

40
Q
  • portion of total authorized shares that are actually sold to investors
A

Issued Shares

41
Q
  • authorized shares that have not yet been sold
A

Unissued Shares

42
Q
  • stock that has been issued (sold to the public) and subsequently bought back by the corporation
  • the company may use this type of stock to fund employee bonus plans or it may be distributed to stockholders in lieu of a cash dividend
  • it might eventually be reissued to the public or simply “retired”
  • note that shares of this type of stock have no voting rights and receive no dividends
A

Treasury Stock

43
Q
  • the number of shares in the hands of investors at any given time
  • this number is calculated by subtracting the number of shares of treasury stock from the number of issued shares

= Issued Shares - Treasury Stock Shares

A

Outstanding Stock

44
Q
  • the number of outstanding common shares times the market price per share
A

Market Cap

45
Q
  1. Right to vote through proxy
  2. Right to transfer ownership
  3. Right to receive dividends once declared
  4. Right to inspect the corporation’s books
  5. Preemptive right
  6. Junior claim to assets in the event of liquidation
A

Rights of Common Shareholders

46
Q
  • this is a limited power of attorney that the stockholder grants to someone else
  • these individuals have the authority to vote the stock either at their discretion or at the instruction of the stockholder
A

Proxy

47
Q
  • one of two voting processes used by corporations
  • shareholders are permitted one vote for each share they own for each vacancy

Total Votes = (Number of Shares x Number of Vacancies)

A

Statutory Voting

48
Q
  • one of two voting processes used by corporations
  • the shareholder has the same number of total votes, however, the shareholder may divide those votes among the vacancies in any way he or she desires
  • this voting process is designed to benefit the small shareholder

– by concentrating the votes on one vacancy, the shareholder has a stronger voice in the election process

A

Cumulative Voting

49
Q
  • the portion of the issuer’s earnings that is paid to stockholders
  • paid quarterly and fluctuate in amount based on the issuer’s earnings
  • only paid when and if declared by the board of directors
  • once declared, it becomes a current liability of that corporation and must be paid
  • normally paid in cash
  • the total dollar amount paid is moved from retained earnings to current liabilities

– since current liabilities have increased, the amount of working capital the corporation has available will decrease

  • individual investors are taxed at ordinary income tax rates whether the term is received in cash or reinvested
  • corporations are entitled to an exclusion that allows them to exclude 50% of the qualified term from corporate income

– the corporation must own less than 20% of the dividend-paying corporation’s outstanding stock

A

Dividends

50
Q
  • on this date, the customer gives a purchase order to his or her broker/dealer (b/d)
  • the b/d then enters into a trade agreement with another b/d to fill the customer’s order
  • two b/d’s agree on a share quantity and price in this legally binding agreement
A

Trade Date

51
Q
  • the b/d’s consummate the terms of their agreement
  • they exchange securities and cash
  • on this date, the buyer becomes the legal owner of the securities

– the buyer’s name is recorded in the corporation’s stockholder record and the seller’s name is removed

  • for corporate securities, this date is normally 2 business days after the trade date (T+2)

– this is the standard practice followed by the securities industry

– it is called regular-way settlement and is required between b/d’s who also ask their customers to comply

A

Settlement Date

52
Q
  • one practice that is occasionally used on the Settlement Date
  • the b/d’s consummate the trade on the same day (or T) that they enter the agreement
  • in other words, the Trade Date and Settlement Date are the same for this type of settlement
  • purchasers become the owners of record on the day they enter purchase instructions
A

Cash Settlement

53
Q
  • the date on which the board of directors declares the dividend and it becomes a current liability
A

Declaration Date

54
Q
  • the first trade date on which the stock purchaser is not legally entitled to receive the dividend
  • the current market value of the underlying stock declines by the amount of the dividend and the stock is said to be trading ex-dividend
A

Ex-Dividend Date

55
Q
  • the date on which the corporation consults the stockholder record
  • only those owners recorded in the stockholder record receive the dividend
A

Record Date

56
Q
  • the date on which the corporation actually distributes dividends to those shareholders of record (as of the record date)
A

Payable Date

57
Q
  • also known as current yield
  • this is a method for measuring a stockholder’s return on investment
  • this yield of a company’s stock can be calculated as follows:

= Annual Dividend / Current Share Price

A

Dividend Yield

58
Q
  • this dividend is paid in the form of shares
  • this is often used by growth companies so they can save cash for future growth
  • this type of dividend causes the outstanding shares to increase, the price per share to decrease, and the total value of the stock to remain the same
A

Stock Dividend

59
Q
  • declared by the issuing corporation, but voted on by the shareholders
  • this involved increasing the amount of outstanding shares with a corresponding decrease in the value of each share

– for instance, a “two-for-one” split is similar to changing a $20 bill into two $10 bills

A

Stock Split

60
Q
  • this stockholder right is the right to maintain the same percentage of ownership in a corporation when new shares are issued
  • before a company offers a new issue of common stock to the public, current shareholders are given the first opportunity to purchase a sufficient number of the new shares to maintain their current percentage of ownership in the company
  • the new shares are offered to current stockholders at a discounted price, referred to as subscription price
  • the corporation issues stock rights to stockholders that can be used to purchase stock, can be sold for value in the marketplace, or can be left to lapse or expire
A

Preemptive Rights

61
Q
  • corporations facilitate the use of stockholders’ preemptive rights by issuing these rights to existing stockholders
  • these rights can purchase stock, can be sold for value in the marketplace, or can be left to lapse or expire
  • they are typically short term, expiring 30 to 60 days after they are issued
  • for every share outstanding, the corporation will issue one right
  • cost basis can be determined by the difference between the current market value of the underlying stock and the exercise price of the right, divided by the number of rights it takes to buy one new share at the exercise price
  • these rights have value themselves because they enable the owner to purchase new shares at a price below the market value
  • the rights include an anti-dilution provision that adjusts prices if a stock split were to occur
A

Stock Rights

62
Q
  • long-term instruments lasting several years (sometimes perpetual)
  • initially issued with an exercise price above the current market value of a stock

– if the subscription price is below the market price, then there is intrinsic value

  • this term makes other securities more marketable when attached to them
  • can be used to lower the interest rate on a bond issued by a corporation
  • usually attached to bonds
  • usually detachable, meaning they can be traded in the marketplace separately from the security with which they were issued
A

Warrant

63
Q
  • certificates issued by the U.S. commercial bank that represent ownership of a foreign company’s shares listed on a foreign exchange
  • each certificate may represent one or more shares of foreign stock, or a fraction of a share
  • the actual shares of a foreign company are held in an American bank called the depository bank

– dividends paid by the foreign company are collected by the depository bank, converted into U.S. dollars, and paid to the investors

– the investor is exposed to currency exchange rate each time so they carry currency risk to investors

  • can be categorized as sponsored or unsponsored
A

American Depository Receipts (ADR’s)

64
Q
  • the issuer provides nearly all SEC mandated info to the investor and dividends are paid through transfer agents in U.S. dollars
  • these ADRs often trade on national exchanges
  • shareholders usually enjoy all the rights associated with ownership of stock, including voting rights
A

Sponsored ADR’s

65
Q
  • shares of this type of ADR are simply held in a bank (usually an American branch bank) located in a foreign country
  • this type of ADR typically trades OTC
  • shareholders usually do not have voting rights
A

Unsponsored ADR’s

66
Q
  • safer than common stock, it has senior claim to common stock when it comes to dividend payment and liquidation
  • stockholders receive the stated dividend before common shareholders receive any dividend
  • have a par value of $100 unless stated otherwise
  • this type of stock was created to yield a fixed, stated return comparable to bonds
  • stockholders for this type of stock usually do not have voting rights
  • similar to bonds, the value of this type of stock is affected by fluctuations in interest rates

– this stock is interest rate sensitive

A

Preferred Stock

67
Q
  • this type of preferred stock can be called from the stockholder by the issuer at the issuer’s discretion
  • this provision is not attractive to investors because it adds risk and uncertainty

– therefore, investors demand a higher stated premium on this type of stock to compensate for added risk

  • the issuer will pay a higher dividend for the advantage of the feature
  • investors have no choice but to tender their stock to the call at the issuer’s discretion
A

Callable Preferred Stock

68
Q
  • this type of preferred stock feature was designed to alleviate years in which the corporation does exceptionally well and the common stock dividend increases to reflect those higher earnings
  • this feature allows preferred stock to participate with common shares in the earnings of an exceptional year
  • in such years, this type of preferred stock would receive a larger dividend than its normal stated dividend

– the larger dividend is usually based on the company’s retained earnings or a percentage of what the company pays in dividends to the common shares

A

Participating Preferred Stock

69
Q
  • this preferred stock provision permits owners to convert, or exchange, their preferred stock for a designated number of common shares
  • this is attractive to investors because it offers immediate benefits associated with the dividend and bankruptcy priority, as well as the potential price appreciation of the common stock in the future

– therefore, corporations can issue this type of preferred stock with lower stated dividends than straight preferred

  • this type of stock has an anti-dilution provision that will adjust the conversion price and conversion ratio in the event of a stock split
A

Convertible Preferred Shares

70
Q
  • pertains to Convertible Preferred Stock
  • this price represents the price at which the shareholder may convert to common shares
A

Conversion Price

71
Q
  • pertains to Convertible Preferred Stock
  • determined at the stock’s issuance, this ratio determines the number of shares that will be received for each share of preferred stock

– this can be calculated by dividing the par value of the preferred stock by the conversion price

A

Conversion Ratio

72
Q
  • this feature gives the preferred stockholders greater assurance that the dividend will be paid
  • no dividends can be paid to common shareholders if any of this type of preferred dividends are in arrears
A

Cumulative Preferred Stock

73
Q
  • this type of preferred stock has a dividend that changes based on the performance of a benchmark security, which is often a U.S. Treasury Bill
  • changes in the dividend are usually based on a pre-established formula, and typically occur quarterly
  • because the dividend adjusts, or “floats”, the stock price stays stable
A

Adjustable Rate Preferred Stock

74
Q
  • this type of preferred stock pays a fixed dividend for a period of time until a specified date, after which the dividend will float
  • the dividend is typically pegged to a benchmark rate, such as the LIBOR, Fed Funds or T-Bill rate, typically
A

Variable Rate Preferred Stock

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