Corporate Securities Introduction

Question 1

What defines a “security” and what are the different types?

Answer 1

On the Series 7 it is important to remember the definition of a security is one that has actually been registered in the states in which it will be offered. Sometimes the Security is exempt from registration.

• Common Stock
• Mortgage Backed Securities
• Options
• Debt Issues llike bonds
• Collateralized Mortgage Obligations
• Warrants

Question 2

Define:

security

What are the different types?

Answer 2

A Security means it has actually been registered in the states in which it will be offered.

Note: On the Series 7 it is important to remember this requirement. Sometimes the Security is exempt from registration.

Six Types:

• Common Stock
• Mortgage Backed Securities
• Options
• Debt Issues llike bonds
• Collateralized Mortgage Obligations
• Warrants

Question 3

What is the liquidation order of a company if company goes out of business and forced to liquidate assets?

Answer 3

• IRS gets paid first
• Secured Bondholders
• Unsecured Bonds
• Creditors such as vendors
• Preferred Shareholders
• Common Shareholders

It’s important to note the stockholder is the last person paid in a liquidation. The equity holder exchanges appreciation potential for security of investment.

This has important implications for the relative safety of investments and will be important to know for evaluating appropriate investments for particular customers.

Question 4

What is the liquidation order of a company if company goes out of business and forced to liquidate assets?

Answer 4

The liquidation order would be:

1. IRS gets paid first
2. Secured Bondholders
3. Unsecured Bonds
4. Creditors such as vendors
5. Preferred Shareholders
6. Common Shareholders

Note: It’s important to note that stockholders are the last paid in a liquidation. The equity holder has exchanged appreciation potential for security of investment.

Question 5

What is the riskiest type securities investing?

Answer 5

Common stock is the riskiest. This is because the shareholder is paid last in the event of a corporate liquidation.

Question 6

What is the riskiest type of securities investing?

Answer 6

**Common Stock **

Common Stock is riskiest because the shareholder is paid last in the event of a corporate liquidation.

Question 7

What is capitalization?

Answer 7

This is the actual process of raising funds in the public market. When you think of vanilla investment banking, this is the process a company goes through to make the issue available to the public. Depending on the type of security this process can vary widely.

Note: This is not market capitalization which is the value of a companies outstanding stock.

Question 8

What is:

Capitalization

Answer 8

Capitalization is the actual process of raising funds in the public market.

When you think of vanilla investment banking, this is the process a company goes through to make the issue available to the public. Depending on the type of security this process can vary widely.

Note: This is not “market capitalization,” which is the value of a company’s outstanding stock.

Question 9

What are the basic features of common stock?

Answer 9

• Could pay a dividend although not guaranteed.
• Very liquid in the secondary (Think stock exchange) market
• Represents ownership in the company
• No liability for the average investor if the company or employees are engaged in illegal activity.

Question 10

What is a CUSIP number?

Answer 10

Think of a CUSIP number as a bar code for a common stock. It is is a unique identifier that helps identify a security and its owner in the event a stock certificate is lost.

This is more imporant in the electronic world where few certificates are actually issued.

Question 11

What does negotiability mean with respect to common stock?

Answer 11

The owner of a common stock has the right to do whaterver they want with that secruity such as give the stock away, sell it, transfer it to a trust. Anything at all.

Question 12

What does stock power mean?

Answer 12

Stock Power is similar to power of attorney. It allows the owner of a stock the ability to sell the security without signing individual certificates.

This is almost unheard of today but sometimes still pops up on the series 7 Exam. It today’s computerized world it is usually within the agreements signed to set up the account.

Question 13

What is a stock charter?

Answer 13

The charter is important for the common shareholder because it contains the detail of how many shares can be sold to the public. Note that during the process of taking a company public and issuing the shares, the board may authorize only a portion of the authorized shares.

The charter also contains all relevant information on a company, who are the officers, and other basic identifying information.

Question 14

What is Par Value for common equity?

Answer 14

Par value is an arbitrary number assiged to the value of the securities as issue but has no real meaning or importance.

On the exams you may see questions about par value; just know that it can be any number and doesn’t impact issuance or stock price in any way.

Question 15

What is the capital surplus of a company?

Answer 15

This is the difference between the market capitalization of all the outstanding stock (not authorized stock) and the stated par value of the stock on the company’s charter. Since par value is an arbitrary number, capital surplus is also fairly meaningless but does come up on the exam from time to time.

Question 16

Define shareholders equity.

Answer 16

This is a simple formula:

Total Assets - Total Liabilities = Shareholders Equity

This is a quick way to see what the stockholders would be left with in the event of a liquidation.

Question 17

Define Book Value

Answer 17

Book value is only an estimation of what the company would be worth if they decided to cease operations and sell all assets. The book value is the total asset component of the stockholders equity formula

Question 18

Define Offering Price

Answer 18

When a company goes public, investment bankers purchase the stock from the company and then make them available to trade on the secondary market. The offering price is the price the stock will be offered to the public.

Note that the market price of a stock will vary widely from the offering or IPO price depending on the public demand for the security at issuance.

Question 19

What are shares called that have been authorized by the board of directors to be sold to the public?

Answer 19

“authorized, issued, and outstanding” shares is a phrase you should remember for the exam because it is distinct from Treasury Stock

Treasury Stock: Shares that have been repurchased by the company and hold no voting or dividend rights.

Question 20

What is the difference between authorized and outstanding shares?

Answer 20

This will be important on the exam and is usually always tested.

Authorized shares represents the number of shares the board has authorized to be issued but does not mean all those shares are actually trading in the market. Shares can be authorized but remain unissued, or not trading publicly. Outstanding shares are those that have been both authorized and acutally issued to the public.

When a company repurchases its own shares in the marketplace, it purchases them from outstanding shares. Those shares then become treasury stock

Question 21

What are the two sides of a stock price quote?

Answer 21

Bid - Ask

The two prices at which a stock is currently trading. The ask or offered price is the price a dealer is “asking” for that stock or where the customer can buy it. The customer buys on the offered side of the price and the dealer sells at that price.

The bid is where a dealer is willing to buy shares from the public. Naturally this will always be less than the ask price.

Question 22

What is the payout ratio of a common stock?

Answer 22

This is the relationship between earnings per share and the dividends paid to the shareholders if the board has actually declared a dividend.

High growth companies that reinvest earnings into the company may declare no divdend and therefore not have a payout ratio.

Other companies such as utility companies that have traditionally offered higher dividends will naturally have higher payout ratios.

The payout ratio of a stock could be used to asses risk for suitability purposes as stocks that are safer tend to have higher payout ratios.

Question 23

How are dividends paid?

Answer 23

Dividends can either be paid in cash, stock or a mix of both. In some cases, a company can declare its products as dividends and issue it to all their shareholders.

Question 24

What are the Three Critical Dates for Dividend Distributions?

Answer 24

• When the board of directors authorizes a dividend to be paid, that is called the declaration date.
• The company secretary will count all the stockholders on a certain day and make those individuals eligible for the declared divident. This is called the record date.
• The date the checks are mailed electronically deposited into an account is called the payable date.

Question 25

What is the ex-dividend date and how does it affect stock prices?

Answer 25

If an investor buys a stock on its ex-dividend date, it is not elegible for the dividend paid that day. The record date will always be two days AFTER the ex-dividend date.

Since the stock is trading without its dividend, it is called the ex-dividend date.

Question 26

What are the different settlment types for common securities?

Answer 26

Stocks typically “settle” in two days meaning they will be reflecting in your account in two days. This is called regular way settlement

If the trade is for cash settlement then they settle on the same day.

Note: Why does any of this matter? Because unless the trade has settled, the investor would not be considered a stock holder on the record date.

Question 27

How do investors vote for vacancies on a companies board of directors?

Answer 27

Shareholders vote via a document called a proxy that is mailed to each shareholder on record.

All proxies are reviewed by the SEC prior to being released to the shareholders.

One share equals one vote.

Question 28

What are the two types of proxy voting?

Answer 28

• Statutory voting means you get to cast votes equal to the shares you own for each board seat vacancy. If you own 100 shares and there are two openings then you may vote all your shares per vacancy and actually cast 200 votes but can only cast a maximium of 100 votes per vacancy.
• Cumulative voting is basically the opposite of statutory. It allows shareholders to multiply their shares by each vacacny and cast them in any way they want, potentially for the same person.

The theory behind cumulative voting is it allows minor or small shareholders some voice in determining the composition of the board.

Question 29

What is the difference between class A common stock and class B common stock?

Answer 29

Class A shares are shares that have voting rights and class B shares are issued without them.

The reason a company would issue class B shares is to allow additional capital raising without giving away an equal amount of voting rights to potentially change management.

Question 30

What is the Pre-emptive right of the common shareholder?

Answer 30

When a company begins to issue new stock to the public, the new issue dilutes the existing shareholders (reduces their actual percentage ownership)

The pre-emptive right of common shareholders is the right to be first inline to purchase an amount of the new issue that would maintain their current percentage ownership.

Example: Investor owns 5% of a company. That company is then issuing a million new shares. That investor has the right to buy 50,000 new shares before anyone else.

Note that the shares are not given to the investor, they still have to make the purchase and they are under no obligation to purchase the new shares.

Question 31

What is a “rights offering” of shares?

Answer 31

This always refers to the process of actually issuing those new shares and has several characteristics.

• Rights offerings have a defined expiration and is usually around a month.
• Shareholders of record own one right for each share they own
• Since this right is basically an option on the stock, it has value just like any other stock option. This option can be un-exercised and sold back to the company - in this case the investor accepts diluation in exchange for the cash.
• One share equals one right but the new issue might require multiple rights per share.

Question 32

What is the formula for the value of a stock right?

Answer 32

Note: there are a few equations you should memorize for the exam. This is one of them

Current Market Price - Subscription price of new issue

Take this value difference and divide by the number of rights required to purchase a new share.

Example: Current price is 40$ and the company is coming to the market with a new share at 38$ and each share requires 5 rights to purchase (Remember: each old share is one right but new shares can require multiple rights to purchase). $40-$38 is a two dollar difference / 5 rights = a $.40 value to each right.

Question 33

What is a stock split and how does it impact a stock’s price?

Answer 33

A stock can be “split” into many smaller shares at lower values so a stock split doesn’t on its own impact the value of what an investor owns.

• A reverse stock split is when the number of shares goes down but each share is worth more
• A stock split is simply the opposite: Shares are split into many more pieces so the number of shares goes up and the price goes down.

Note: Stock splits will also change the par value of the company stock in the exact same way.

Question 34

What are the risks a stock owner faces?

Answer 34

• Decrease in market price or anticipated dividends not realized - Market Risk
• Common shareholders only have the final right to assets (residual claims) if a company goes bankrupt. - Business Risk

Question 35

What are the broad categories usually used to describe a particular segment or industry?

Answer 35

• Growth
  
  • Usually medical or tech companies, pay few dividends and risky
• Income
  
  • Stocks that have high dividend payout ratios
• Defensive
  
  • Stocks that hold value through the business cycle like food and tobacco.
• Cyclical
  
  • Earnings and stock price can tightly track business cycle like heavy equiment or automobiles.