Chapter 2 Def Flashcards
What is a Security?
Any investment product that can be exchanged for value and involves risk.
It must be readily transferable between two parties and the owner must be subject to the loss of some, or all, of the invested principal. Must be transferable; Must contain risk.
What are types of Securities
Stocks Bonds Mutual funds Variable annuities Variable life insurance Options Rights Warrants Exchange traded funds & exchange trade notes ETFs / ETNs CMO American depository receipts
What is Equity?
Creates an ownership relationship with the issuing company. Once an investor has purchased stock in a corporation, he or she becomes an owner of that corporation. The corporation sells off pieces of itself to investors in the form of shares in order to raise working capital. It is perpetual, meaning that there is no maturity date for the shares and the investor may own the shares until he or she decides to sell them. Most corporations use the sale of stock as their main source of business capital.
What is Authorized Stock?
The maximum number of shares that a company may sell to the investing public in an effort to raise cash to meet the organization’s goals. The number of shares is arbitrarily determined and is set at the time of incorporation. A corporation may sell all or part of its this type of stock. If the corporation wants to sell more shares than it’s authorized to sell, the shareholders must approve an increase in the number of these shares.
What is Issues Stock?
stock that has been authorized for sale and that has actually been sold to the investing public. The total number of authorized shares typically exceeds the total number of this type of shares so that the corporation may sell additional shares in the future to meet its needs. Once shares have been sold to the investing public, they will always be counted as issued shares, regardless of their ownership or subsequent repurchase by the corporation. It’s important to note that the total number of these shares may never exceed the total number of authorized shares.
Additional authorized shares may be issued in the future for any of the following reasons:
- Pay a stock dividend.
- Expand current operations.
- Exchange common shares for convertible preferred or convertible bonds.
- To satisfy obligations under employee stock options or purchase plans.
What is Outstanding Stock?
Stock that has been sold or issued to the investing public and that actually remains in the hands of the investing public.
What is Treasury Stock?
Stock that has been sold to the investing public and then subsequently repurchased by the corporation. The corporation may elect to reissue the shares or it may retire the shares that it holds in treasury stock. This type of stock does not receive dividends nor does it vote.
Why might a Company repurchase Stock?
- To maintain control of the company.
- To increase earnings per share.
- To fund employee stock purchase plans.
- To use shares to pay for a merger or acquisition.
Formula for Treasury Stock
Issued stock – outstanding stock = treasury stock
Book Value
The theoretical liquidation value of the company.
Formula for Book Value
Total Tangible assets - Total Liabilities
Book Value per Share
Total book value / Total number of outstanding common shares.
What is Par Value?
In a discussion regarding common stock, is only important if you are an accountant looking at the balance sheet. An accountant uses the par value as a way to credit the money received by the corporation from the initial sale of the stock to the balance sheet. For investors, it has no relationship to any measure of value that may otherwise be employed.
Residual Claim to Assets
After all the other security holders have been paid, along with all creditors of the corporation, common stockholders may claim the residual assets. For this reason common stock is the most junior security.
Blue Chip Stocks
strong, stable and mature, with a long history of consecutive quarterly dividends; may also be a suitable investment for an investor with an income objective.
Growth Stocks
Strong potential for improving profits. The company’s earnings are growing faster than the overall economy, and thus the stock has a strong potential for outperforming the market.
Emerging Growth Industry Stocks
Young firm in new industry with good growth prospects, but also high-risk.
Income Stocks
Mature company with high dividend yield and few prospects for growth or diversification. These are typically utility companies; however, they may also be blue chip companies.
Common Stock Classes (Company Type)
- Blue Chip
- Growth
- Emerging Growth Industry
- Income
Common Stock Classifications (Characteristics)
- Cyclical
- Counter Cyclical or Defensive
- Speculative
Cyclical Stock
Moves with the broader market - and often with greater volatility - so they outpace the market during an expansion but whipsaw back during a contraction. Automotive stocks are one example.
Counter Cyclical or Defensive Stock
Do better in bear markets, when investors are looking for safe places - that are not affected greatly by economic currents - to park their money. Companies in the food, health care and defense industries are all examples.
Speculative Stock
special situation stocks are those that, for whatever reason, an investor believes will rise quickly in market price. There can be an element of guesswork here, but other factors may be at play too. Often, these are companies emerging from reorganization or bankruptcy. Sometimes investors will be drawn by the fact that a company’s incompetent or corrupt management is being replaced by turnaround specialists. Alternatively, it might be that a company is either fundamentally undervalued or selling at the low end of its historic trading range and is thus ripe for a sharp upward movement in stock price
Dividend
a taxable payment declared by a company’s directors and paid to shareholders out of the company’s retained earnings. Usually paid quarterly (doesn’t have to be cash, not req)
Payment of Dividends
Declaration Date (D0) Ex Dividend Date (D8) Record Date (D10)
Ex Dividend Date
A security is “ex-dividend” if it no longer carries the right to receive the most recently declared dividend. By convention, this is two business days before the record date.
Record Date
the date by which an investor must own the share to be entitled to a dividend. If a seller wants to sell the stock and still be able to keep the dividend, he must do so no earlier than two business days before
Stock Split
occur when a company believes its share price is too high to be attractive for individual investors to purchase. The perception is that if a stock exceeds $100, people start looking for “cheaper” stocks, so the company may do this to each outstanding $100 share into two $50 shares; of course, there is no net difference in value.
Reverse Split
Merging of several stocks into one
Preferred Stock
Non-voting, but they pay a steady dividend. They have other benefits too:
If a company is to be liquidated, stockholders have priority over common stockholders.
If a company does not have enough earnings in a period to pay dividends to both type of stockholders, these be the ones paid.
Types of Preferred Stock
Straight/Non Cumulative Cumulative Participating Convertible Callable Adjustable Rate
Preemptive Rights
As a stockholder, an investor has the right to maintain a percentage interest in the company.
Rights Offering
present common stock to current shareholders at a discount. Rights can be exercised, sold to another party or the rights may simple expire unexercised. They cannot be sold back to the company for cash. If rights are not exercised during a brief window of opportunity, they simply expire.
Warrants
a security that gives the holder the opportunity to purchase common stock. Generally have longer expiration periods than rights do, and they may have no expiration date at all. They can be detached from, and traded separately from, the bonds with which they were issued.
American Depository Receipts (ADR’s)
Issued by U.S. banks and represent the ownership of a foreign stock.
Let’s say you bought 800 shares of Descartes Corporation common shares at $10 six months ago. The price shot up quickly, and it looked like there was no end in sight. Three months later you bought another 200 shares at $18. But this past month, as the share price stalled out at $20, you figured the rocket ride was over and Descartes stock had a lot more downside potential than upside, so you sold 500 of your 1,000 shares and kept the rest because you still believe that Descartes has strong long-term potential.
How much did you make? (fifo vs lifo)
500 shares sold for $20/share = $10,000 net profit
FIFO: 500 * $10 = $5,000
Net Profit of $10,000 - FIFO valuation of $5000 = $5000
LIFO: (200 * 18) + (300 * 10) = $6,600
Net Profit of $10,000 - LIFO valuation of $6,600 =
$3,400
Specific Shares Method
Valuating Profit by date of purchace, for tax purposes.
How are Gifted Securities Valued?
Securities given as gift are to be valued by the donor at the market value on the day of the transfer. To the recipient this could well be taxable income, and she should value it as if she purchased it for $0. Shares that are inherited are valued at the fair market value on the date of death. Any gain will be based off of the market value of the securities on the date of death and not on the original purchaser’s cost base.
Conversion
the exchange of a convertible type of asset into another type of asset, usually at a predetermined price, on or before a predetermined date. The conversion feature is a financial derivative instrument that is valued separately from the underlying security. Therefore, an embedded conversion feature adds to the overall value of the security.
