Chapter 5 - Fundamentals of Equity Investments

Question 1

______ stock is stock that was issued and repurchased by the issuing corporation

Answer 1

Treasury stock is stock that was issued and repurchased by the issuing corporation.

Question 2

True or False: Treasury stock has no voting rights and receives no dividends

Answer 2

True

Question 3

Issued stock - Treasury stock = __________

Answer 3

Issued stock - Treasury stock = Outstanding Stock

Question 4

The __________ date is the date by which stock must be owned to receive the dividend.

Answer 4

The Record date is the date by which stock must be owned to receive the dividend.

Question 5

The ex-dividend date occurs ___ business days ______ the record date.

Answer 5

The ex-dividend date occurs 2 business days before the record date.

Question 6

For the exam, name the three market holidays that could impact a trade’s settlement date.

Answer 6

• January 1
• July 4
• December 25

Question 7

Who are considered the owners of a corporation?

Answer 7

Common and preferred stockholders

Question 8

True or False: All owners have the right to vote.

Answer 8

False.

Only common stockholders have the right to vote.

Question 9

Name two issues on which common stockholders may vote.

Answer 9

• Board of Directors elections
• Stock Splits

Question 10

What voting method permits one vote for each share owned to be voted for each director?

Answer 10

Statutory

Question 11

This voting method allows stockholders to multiply the number of shares owned by the number of directorships.

Answer 11

Cumulative Voting

Question 12

True or False: Cumulative voting benefits smaller shareholders since they can concentrate votes for a specific director.

Answer 12

True.

However, it does not guarantee them representation on the board.

Question 13

_________ stock fluctuates with the business cycle.

Answer 13

Cyclical stock fluctuates with the business cycle. (auto companies)

Question 14

_______ stock is resistant to recession.

Answer 14

Defensive stock is resistant to recession. (utility companies)

Question 15

What instruments are used to facilitate trading of foreign securities in the U.S.?

Answer 15

American Depositary Receipts (ADRs)

Question 16

Warrants are a _____-term right to buy stock at a preset price.

Answer 16

Warrants are a long-term right to buy stock at a preset price.

Question 17

True or False: Warrants are generally attached to the delivery of another security (stock or bond).

Answer 17

True

Question 18

What is the longest duration for a warrant?

Answer 18

Perpetual

Question 19

May a warrant be detached and traded separately?

Answer 19

Yes

Question 20

Rights are a _____-term instrument allowing holders to buy additional shares at a discounted price.

Answer 20

Rights are a short-term instrument allowing holders to buy additional shares at a discounted price.

Question 21

What is the advantage existing stockholders receive through rights offerings?

Answer 21

The ability to maintain their percentage of ownership and buy additional shares at a discount.

Question 22

Existing stockholders receive _____ right for every one share owned.

Answer 22

Existing stockholders receive one right for every one share owned.

Question 23

What is the method to calculate the number of shares that can be purchased through a rights offering?

Answer 23

of rights received

÷

of rights needed to buy each additional share

Question 24

Name two priorities that preferred stock has over common stock.

Answer 24

Order of liquidation and dividends

Question 25

$____ is normally the par value for preferred stock

Answer 25

$100 is normally the par value for preferred stock

Question 26

Describe cumulative preferred stock

Answer 26

Stock that requires payment of any missing dividends before common stockholders are paid.

Question 27

True or False: Convertible preferred stock may be converted into a bond.

Answer 27

False.

Convertible securities are convertible into common stock.

Question 28

The formula for finding conversion ratio on convertible preferred stock is ______ ÷ __________

Answer 28

The formula for finding conversion ratio is: Par ÷ Conversion Price (par for preferred is $100)

Question 29

What is a derivative?

Answer 29

A financial product that derives its value from the value of underlying assets such as stocks, bonds, or mortgages

Question 30

When warrants are attached to bonds, will the issuers pay a higher or lower rate of interest?

Answer 30

Lower, due to the added opportunity

Question 31

True or False: Corporations receiving dividends from other corporations qualify for the dividend exclusion rule.

Answer 31

True

Question 32

The corporate dividend exclusion rule applies to dividends paid on both ________ and ________ stock.

Answer 32

The corporate dividend exclusion rule applies to dividends paid on both common and preferred stock

Question 33

A corporation with less than 20% ownership in a company paying dividends may exclude ___% of the dividend from taxes.

Answer 33

A corporation with less than 20% ownership in a company paying dividends may exclude 70% of the dividend from taxes.

Question 34

What is the tax consequence for an investor who receives a stock dividend?

Answer 34

Her cost basis must be adjusted.

Question 35

Does the receipt of a stock dividend create a taxable event?

Answer 35

No, not until the stock is actually sold.

Question 36

Joe owns 100 shares of MNO at $20 (total cost $2000). If MNO declares a 10% stock dividend, what is Joe’s new basis?

Answer 36

Original cost ÷ new total number of shares

($2,000 ÷ 110 shares = $18.18)

Question 37

If not designated by a client at the time of sale, what method will the IRS use to determine which shares were sold?

Answer 37

FIFO

(first-in, first-out)

Question 38

A client selling shares would like to determine the specific shares being sold, he should use __________.

Answer 38

A client selling shares would like to determine the specific shares being sold, he should use Specific Identification.

Question 39

If an investor does not use Specific Identification when selling securities, the IRS assumes ____________.

Answer 39

If an investor does not use Specific Identification when selling securities, the IRS assumes FIFO (first-in, first-out)

Question 40

A sale for a loss would trigger the wash sale rule if the same security is repurchased within ____________.

Answer 40

A sale for a loss would trigger the wash sale rule if the same security is repurchased within 30 days of the sale.

Question 41

According to the wash sale rule, what securities are considered substantially the same?

Answer 41

Same stock, rights, warrants, a bond or preferred stock convertible into the stock, or the purchase of a call option

Question 42

Joe sells XYZ and claims a 5-point loss, but triggers the wash sale by repurchasing XYZ at $40. Joe’s cost basis is:

Answer 42

$40 + 5 point loss = $45 (The disallowed loss is added to the new purchase.)

Question 43

Ken covers a short position at a loss and re-shorts the same position within 30 days. Is the wash sale rule triggered?

Answer 43

Yes

Question 44

In a bond swap (bond sold at a loss and another purchased), what features need to be changed to not trigger a wash sale?

Answer 44

Change the issuer, or the coupon, or the maturity

Question 45

True or False: A wash sale is triggered if the difference in a bond sold and then repurchased is accrued interest/price.

Answer 45

True.

To not trigger the wash sale rule, the issuer, coupon, or maturity must be changed.

Question 46

Define the term basis.

Answer 46

The total cost to acquire an asset.

Question 47

If securities are inherited, a beneficiary’s holding period is automatically __________.

Answer 47

If securities are inherited, a beneficiary’s holding period is automatically long-term (regardless of previous owner’s).

Question 48

Pete just inherited securities from his grandfather and is asking about his basis. What is the correct response to Pete?

Answer 48

His basis is the market value at the time of his grandfather’s death (stepped up basis).

Question 49

How is basis determined for the recipient of gifted securities?

Answer 49

Basis will be the donor’s cost or market value, whichever is lower.

Question 50

When securities are gifted, the recipient’s holding period will be ____________.

Answer 50

When securities are gifted, the recipient’s holding period will be the same as the donor’s.

Question 51

True or False: Common stockholders have the right to vote for the payment of dividends

Answer 51

False.

Dividend payments are determined by the board of directors.

Question 52

True or False: Both common and preferred stockholders are offered preemptive rights.

Answer 52

False.

Preemptive rights are only offered to common stockholders.

Question 53

If a corporation executes a stock split, is there a resulting gain or loss for existing stockholders?

Answer 53

No, the overall position stays the same.

Forward = more shares at lower price;

Reverse = fewer shares at higher price.

Question 54

ABC sets a record date of Wednesday, Oct. 19. Would a buyer of ABC on Monday, October 17 be entitled to the dividend?

Answer 54

No, the investor must own (trade settles) on or before the record date. This trade would not settle until October 20.

Question 55

XYZ’s record date is Thursday, May 3. With a regular-way trade, when could Emma sell her stock, but keep the dividend?

Answer 55

On Tuesday, May 1 or later. She must remain the owner at least through May 3 to keep the dividend

Question 56

What can a U.S. investor do when foreign taxes are paid on dividends received on foreign stocks?

Answer 56

The amount of the foreign tax can be claimed as a credit or deduction on her U.S. return.

Question 57

A corporation with 20% or more ownership in a company paying dividends may exclude ___% of the dividend from taxes.

Answer 57

A corporation with 20% or more ownership in a company paying dividends may exclude 80% of the dividend from taxes.

Question 58

Cash dividends received by individuals are generally taxed at a maximum rate of ___%

Answer 58

Cash dividends received by individuals are generally taxed at a maximum rate of 20%

Question 59

True or False: A stockholder is able to vote for a director, but not an officer.

Answer 59

True

Question 60

________ stock pays higher than average dividends.

Answer 60

Income stock pays higher than average dividends

(e.g., stocks of utility companies).