Chapter 2 Def

Question 1

What is a Security?

Answer 1

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.

Question 2

What are types of Securities

Answer 2

Stocks
Bonds
Mutual funds
Variable annuities
Variable life insurance
Options
Rights
Warrants
Exchange traded funds & exchange trade notes ETFs / ETNs
CMO
American depository receipts

Question 3

What is Equity?

Answer 3

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.

Question 4

What is Authorized Stock?

Answer 4

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.

Question 5

What is Issues Stock?

Answer 5

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.

Question 6

Additional authorized shares may be issued in the future for any of the following reasons:

Answer 6

1. Pay a stock dividend.
2. Expand current operations.
3. Exchange common shares for convertible preferred or convertible bonds.
4. To satisfy obligations under employee stock options or purchase plans.

Question 7

What is Outstanding Stock?

Answer 7

Stock that has been sold or issued to the investing public and that actually remains in the hands of the investing public.

Question 8

What is Treasury Stock?

Answer 8

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.

Question 9

Why might a Company repurchase Stock?

Answer 9

1. To maintain control of the company.
2. To increase earnings per share.
3. To fund employee stock purchase plans.
4. To use shares to pay for a merger or acquisition.

Question 10

Formula for Treasury Stock

Answer 10

Issued stock – outstanding stock = treasury stock

Question 11

Book Value

Answer 11

The theoretical liquidation value of the company.

Question 12

Formula for Book Value

Answer 12

Total Tangible assets - Total Liabilities

Question 13

Book Value per Share

Answer 13

Total book value / Total number of outstanding common shares.

Question 14

What is Par Value?

Answer 14

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.

Question 15

Residual Claim to Assets

Answer 15

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.

Question 16

Blue Chip Stocks

Answer 16

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.

Question 17

Growth Stocks

Answer 17

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.

Question 18

Emerging Growth Industry Stocks

Answer 18

Young firm in new industry with good growth prospects, but also high-risk.

Question 19

Income Stocks

Answer 19

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.

Question 20

Common Stock Classes (Company Type)

Answer 20

1. Blue Chip
2. Growth
3. Emerging Growth Industry
4. Income

Question 21

Common Stock Classifications (Characteristics)

Answer 21

1. Cyclical
2. Counter Cyclical or Defensive
3. Speculative

Question 22

Cyclical Stock

Answer 22

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.

Question 23

Counter Cyclical or Defensive Stock

Answer 23

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.

Question 24

Speculative Stock

Answer 24

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

Question 25

Dividend

Answer 25

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)

Question 26

Payment of Dividends

Answer 26

Declaration Date (D0)
Ex Dividend Date (D8)
Record Date (D10)

Question 27

Ex Dividend Date

Answer 27

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.

Question 28

Record Date

Answer 28

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

Question 29

Stock Split

Answer 29

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.

Question 30

Reverse Split

Answer 30

Merging of several stocks into one

Question 31

Preferred Stock

Answer 31

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.

Question 32

Types of Preferred Stock

Answer 32

Straight/Non Cumulative
Cumulative 
Participating
Convertible
Callable 
Adjustable Rate

Question 33

Preemptive Rights

Answer 33

As a stockholder, an investor has the right to maintain a percentage interest in the company.

Question 34

Rights Offering

Answer 34

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.

Question 35

Warrants

Answer 35

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.

Question 36

American Depository Receipts (ADR’s)

Answer 36

Issued by U.S. banks and represent the ownership of a foreign stock.

Question 37

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)

Answer 37

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

Question 38

Specific Shares Method

Answer 38

Valuating Profit by date of purchace, for tax purposes.

Question 39

How are Gifted Securities Valued?

Answer 39

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.

Question 40

Conversion

Answer 40

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.