EQUITIES

Question 1

Which term applies to common stock?

a. convertible
b. redeemable
c. non-negotiable
d. non-callable

Answer 1

The best answer is D.
Common stock is a negotiable (transferable) security that cannot be called by the issuer. It is not redeemable with the issuer nor is it convertible. Only preferred stock and bonds can be convertible.

Question 2

A proxy given to a caretaker to vote a stockholder’s shares is a:

A.   power of attorney 
B.   trading authorization 
C.   discretionary authority 
D.   voting trust

Answer 2

The best answer is A.
When a shareholder cannot attend the annual meeting and vote, the shareholder can give a power of attorney to another individual or the management of the company to “stand in” and cast that shareholder’s votes as directed. This is called a “proxy,” where the individual granted the power of attorney acts as the shareholder’s proxy. The “caretaker” wording used in the question is a little odd, but that individual granted the proxy must act in the shareholder’s interests, so this person could be viewed as a caretaker.

Question 3

DUPA Corp. has a Price/Earnings multiple of 20 and a market price of $45. What was the corporation’s Earnings Per Common Share?

a. $.225
b. $.44
c. $2.25
d. $4.44

Answer 3

The best answer is C.
The Earnings per Share can be found by taking the:
Market Price/Multiple = Earnings Per Share
45/20 = $2.25

Question 4

Which statement is TRUE regarding a corporation that has adopted cumulative voting?
A. Each stockholder must accumulate his votes and cast them for one director
B. Minority stockholders have a greater ability to elect the director of their choice
C. Each director must be elected by a majority of the shareholders
D. Minority stockholders are given proportionately more votes than majority stockholders

Answer 4

The best answer is B.
Under “cumulative” voting, shareholders can accumulate their votes and place them on any directorship (or combination of directorships). Thus, minority shareholders who place all of their accumulated votes on 1 director have a reasonable chance of electing that person.

The statement that each shareholder must accumulate his votes and cast them for 1 director is false - the votes are accumulated and can be cast as the stockholder sees fit.

The statement that each director must be elected by a majority of the shareholders is incorrect - each director must be elected by a majority of the outstanding shares.
The statement that minority shareholders are given proportionately more votes than majority shareholders is incorrect - the benefit of cumulative voting is that the minority shareholder can vote all of his votes for 1 (or for a few) director(s), and by virtue of the extra weight of those votes, get the director(s) elected.

Question 5

All of the following features are common to both preferred stock and bonds EXCEPT:

A. fixed rate
B. periodic payments
C. can be callable
D. fixed maturity date

Answer 5

The best answer is D.
Preferred stock has no maturity - its life is indefinite. Bonds have a stated maturity date. Both preferred and bonds are fixed rate, can be callable, and typically make semi-annual payments to holders.

Question 6

Which of the following would be considered owners of a corporation?

A. Only Common Shareholders
B. Both Common and Preferred Shareholders
C. Right Holders
D. Warrant Holders

Answer 6

The best answer is B.

“Owners” have an equity position - and the only owners of a company are shareholders - both common and preferred.

Right holders have a short term option to buy the stock; warrant holders have a long term option to buy the stock. Both rights and warrants are considered to be “equity-related” securities. They have neither an equity nor creditor stake in the corporation.

Question 7

Which security of the same issuer is likely to give the highest current yield?

A. warrant
B. common stock
C. convertible preferred stock
D. non-convertible preferred stock

Answer 7

The best answer is D.
Warrants give no yield. Common stocks give the lowest yields since there is direct growth potential in the price of the stock as reported earnings increase. Convertible preferred yields are higher than common yields but not as high as non-convertible yields. A non-convertible preferred stockholder gets a fixed rate of return without any growth potential. A convertible preferred stockholder can convert to common if the common’s price rises, so growth potential is included. Because of this, yields for convertible preferred are lower than for non-convertible preferred.

Question 8

ABC Corp. has a market price of $15 and a Price/Earnings multiple of 10. What was the corporation’s Earnings Per Common Share?

A. $.67
B. $1.50
C. $10
D. This cannot be determined

Answer 8

The best answer is B.
The Earnings per Share can be found by taking the:
Market Price/Multiple = Earnings Per Share
15/10 = $1.50

Question 9

Which of the following is the right of a common shareholder?

A.   Right to manage    B.   Right to interest    C.   Right to receive a dividend 
D.   Right to vote on the payment of dividends

Answer 9

The best answer is C.
The common shareholder does not manage the company! She has the right to receive a dividend (if declared and paid) but NOT the right to vote on whether or not dividends will be paid. Interest is paid to bondholders; not stockholders.

Question 10

A customer buys 100 shares of preferred at $80 per share. The par value is $100. The dividend rate is 10%. The customer will receive how much in each dividend payment?

A.   $400    B.   $500    C.   $800 
D.   $1,000

Answer 10

The best answer is B.
Preferred dividends are based on a stated percentage of par value. The stated rate is 10% of $100 par = $10 annual dividend per preferred share. Since there are 100 shares, the annual dividend is $1,000. Remember, though, that preferred dividends are paid twice a year, so each payment will be for $500.

Question 11

Preferred stock market valuation is based primarily upon:

A.   future earnings expectations for the issuer    B.   short term market interest rate levels    C.   long term market interest rate levels 
D.   future dividend payment expectations for the issuer

Answer 11

The best answer is C.
Preferred stock prices are based on market interest rates. Preferred stock is a fixed income security, and hence, when market interest rates move, the yield on the security adjusts to the market rate. When interest rates rise, preferred stock prices fall, increasing the yield on the security; and when interest rates fall, preferred stock prices rise, decreasing the yield on the security.

Question 12

All of the following statements about warrants are true EXCEPT?

A.   Warrants are issued to make corporate senior securities offerings more attractive to investors    B.   Warrants typically give the holder a perpetual interest in the issuer's underlying common stock 
C.   Warrants trade separately from the stock of the company    D.   Warrants have a longer term than rights

Answer 12

The best answer is B.

Warrants are typically attached to debt and preferred stock offerings (these securities are “senior” to the common stock of the issuer) to make the securities more attractive to purchasers.

Warrants trade separately from the stock of the company. And lastly, warrants typically have a fixed life of 5 years or less and then expire (this is longer than the expiration of rights).

Perpetual means everlasting. Companies can issue perpetual warrants, but rarely do so.

Question 13

Which of the following do NOT have an equity position?

A.   Convertible preferred shareholders 
B.   Preferred shareholders    C.   Convertible debenture bondholders    D.   Common shareholders

Answer 13

The best answer is C.
Bondholders, whether or not their bonds are convertible, do not have an equity position. Common and preferred shareholders have an equity position.

Question 14

Which statement is TRUE about American Depositary Receipts?

A.   ADR holders have voting and pre-emptive rights    B.   ADRs facilitate domestic trading of U.S. securities in foreign markets    C.   holders are entitled to dividends if declared 
D.   ADRs are issued by foreign banks

Answer 14

The best answer is C.
ADRs facilitate domestic trading of foreign securities. They are issued by domestic banks. ADR holders receive dividends but have neither voting nor pre-emptive rights.

Question 15

Voting of the common stockholder is required for all of the following EXCEPT:

A. when a corporation declares a stock split
B. when a corporation declares a stock dividend
C. when a corporation wishes to issue convertible securities
D. deciding whether to accept a tender offer for the company’s shares

Answer 15

The best answer is B.

Dividend decisions are made by the Board of Directors - no shareholder approval is required. This is true whether a cash or stock dividend is being declared. Changes in the equity capitalization of a company require shareholder approval. A stock split changes par value per share, which requires a shareholder vote. The issuance of convertible securities (which can be converted to equity) is potentially dilutive to the existing common shareholders. They must vote to permit this.

A tender offer is when someone outside the company makes an offer to the existing shareholders to buy their shares, typically at a premium to the current market price. The shareholder can choose to tender or not. If the shareholder chooses to tender, he or she is “voting” to sell the shares to the maker of the offer.

Question 16

A company’s common stock is selling in the market at a “multiple” of 15. If the market price of the common stock is currently $15, what is the earnings per share?

A. $.10
B. $.15
C. $.30
D. $1.00

Answer 16

The best answer is D.
When a stock is selling at a “multiple” of 15, this means that the market price is 15 times the current earnings per share. Since the market price is at $15 and the P/E ratio is 15, earnings per share is $1.00.

Question 17

Cumulative voting is considered to be an advantage to the:

A. large investor
B. institutional investor
C. small investor
D. novice investor

Answer 17

The best answer is C.
Cumulative voting allows a disproportionate voting weight to be placed on selected directors and is considered to be an advantage for the small investor who wishes to have specific directors elected.

Question 18

ABC Corporation has recently completed a $20,000,000 offering of 10% debentures due in 2035. Each bond was sold with a warrant attached that allows the holder to buy 10 shares of ABC common stock at $50 per share. The market price of ABC is currently $42. All of the following statements are true EXCEPT:

A.   The warrants help to increase the issue's marketability 
B.   The warrants help to lower the interest cost on the issue    C.   The warrants are "under water"    D.   The company will raise an additional $5,000,000 if the warrants are exercised

Answer 18

The best answer is D.

Warrants are “sweeteners” that are attached to bond and preferred stock offerings to make them more marketable. Because the warrants have potential value, the issue can typically be sold at a lower interest cost (higher price) than if the warrants were not attached.

At issuance, the warrants are usually issued “out the money” - as in this example the warrants allow the stock to be purchased at $50 but the stock’s current value is $42. Thus, these warrants are said to be “under water” and will not have real value until the stock price rises above $50.

If the warrants are exercised, the 20,000 debentures issued ($20,000,000/ $1,000 par) can be converted into 10 shares of stock each for a total issuance of 200,000 shares. The company will receive $50 per share, for a total of $10,000,000.

Question 19

PDQ Company $1 par common stock currently trading at $55. PDQ is currently paying a quarterly common dividend of $1.10 per share. The current yield of PDQ stock is:

A.   2.0%    B.   4.4%    C.   8.0% 
D.   44.0%

Answer 19

The best answer is C.

Yields are based on annual return. The formula for current yield is:
Annual Income/Market Price = Current Yield
$4.40/$55 = 8%

Question 20

The Price / Earnings Ratio is a measure of:

A. profitability
B. valuation
C. volatility
D. velocity

Answer 20

The best answer is B.
The P/E ratio of a company is a valuation measure. Companies with high P/E ratios are being valued very highly by the market; while those with low P/E ratios are being valued at a low level. Rapidly growing companies tend to have high P/E ratios, while mature companies tend to have low P/E ratios.

Question 21

XYZ Company has issued 10%, $100 par cumulative preferred stock. Two years ago, XYZ omitted its preferred dividend. Last year, it paid a preferred dividend of $5 per share. This year, XYZ wishes to pay a common dividend. In order to make the distribution to common shareholders, each preferred share must be paid a dividend of:

A. $5
B. $15
C. $20
D. $25

Answer 21

The best answer is D.
Since the preferred stock is cumulative, to make a dividend distribution to common shareholders, the company needs to pay all back, unpaid dividends plus this year’s dividend (before a common dividend can be paid). The stated dividend rate on the preferred is 10% based on $100 par. Two years ago the entire dividend was omitted, so $10 per share must be paid. Last year, the corporation only paid $5, so there is another $5 that must be paid. Also, this year’s dividend of $10 must be paid. The total dividend that must be paid is $25 per preferred share before a common dividend can be paid.

Question 22

During periods of stable interest rates and increasing stock prices, which type of preferred stock will have the greatest price volatility?

A.   Cumulative 
B.   Reset    C.   Callable    D.   Convertible

Answer 22

The best answer is D.

Preferred stock is a fixed income security, similar to a bond, where the price of the security moves inversely to interest rate movements. If interest rates are stable, this implies that preferred stock prices will be stable as well. However, convertible preferred stock, if the price of the stock moves up above the conversion price, trades at parity to the equivalent number of common shares into which the preferred stock can be converted. Thus, as the market price of the common stock rises (which has nothing to do with interest rate movements), the price of the preferred will move up as well.

Virtually all preferred stock is cumulative - if the company misses preferred dividend payments, then before it can pay a common dividend, it must make up all unpaid preferred dividend payments.

Callable preferred gives the issuer the right to call in the preferred at a pre-established price, which the issuer would do if market interest rates fell. This would tend to suppress the upward movement of the stock price to no more than the call price as market interest rates fell. In a period of stable interest rates, the issuer has no reason to call the preferred stock.

Reset preferred “resets” the dividend rate as market interest rates move (also called adjustable rate preferred) - so it is a variable rate security. In a period of stable interest rates, the dividend rate would be unchanged and therefore the price of the preferred stock will be stable as well (unless the credit quality of the issuer deteriorated, jeopardizing the dividend payment - this event would cause the price of the preferred shares to drop).

Question 23

Which statement is TRUE when comparing convertible preferred stock and non-convertible preferred stock?

A. Convertible preferred shares will have a higher yield than similar non-convertible shares of the same issuer
B. Non-convertible preferred shares and convertible shares of the same issuer typically have the same yield
C. Non-convertible preferred shares will have a higher yield than similar convertible shares of the same issuer
D. Non-convertible preferred stockholders will benefit as the common stock price rises

Answer 23

The best answer is C.
Non-convertible preferred yields are higher than convertible yields. A non-convertible preferred stockholder gets a fixed rate of return without any growth potential. A convertible preferred stockholder can convert to common if the common’s price rises, so growth potential is included. Because of this, yields for convertible preferred are lower than for non-convertible preferred.

Question 24

Stockholder approval is needed if a corporation wishes to:

A. pay a cash dividend
B. split its stock 2 for 1
C. repurchase shares for its Treasury
D. pay a stock dividend

Answer 24

The best answer is B.
Stockholder approval is needed for a stock split, because it changes the par value of the stock. The state in which the company is incorporated typically requires shareholder approval of a par value change. In contrast, dividend decisions, either in cash or stock, do not require shareholder approval because they are “paid” out of retained earnings and do not affect par value per share. They are made solely by the Board of Directors of the company. The repurchase of shares for Treasury will boost earnings per share, because there will be fewer shares outstanding. This boosts the value of the existing common shares, so no shareholder approval is required. This is another decision that is made solely by the Board of Directors.

Question 25

Which statement is BEST regarding participating preferred stock?

A.   The dividend rate is fixed    B.   The dividend rate varies depending on the decision of the Board of Directors 
C.   The dividend rate is fixed as to maximum but not as to minimum     D.   The dividend rate is fixed as to minimum but not as to maximum

Answer 25

The best answer is D.
Participating preferred pays a fixed dividend rate but also participates with common in “extra” dividends declared by the Board of Directors. Therefore, the dividend rate is fixed as to minimum but not as to maximum.

Question 26

All of the following are terms associated with preferred stock EXCEPT:

A. renewable
B. cumulative
C. negotiable
D. convertible

Answer 26

The best answer is A.
Preferred stock is not a renewable security; there is no stated maturity or redemption date. Preferred stock is a negotiable security, meaning that it is traded. Preferred stock can be callable, cumulative, and convertible.

Question 27

Which statement is TRUE regarding ADRs?

A.   ADRs are vehicles for trading United States securities in foreign countries    B.   ADRs are vehicles for trading foreign securities in other overseas markets    C.   ADR market prices are influenced by foreign currency exchange fluctuations 
D.   ADRs must be registered with the SEC

Answer 27

The best answer is C.

ADRs are vehicles for trading foreign securities in the United States. Foreign companies do not want to list their actual shares for trading in the U.S. because the shares would then have to be registered with the SEC and the company would have to comply with U.S. financial reporting rules (and all of that is expensive).

Since dividends on ADRs are declared by the foreign company in local currency, and are then converted into U.S. dollars and remitted to the receipt holders by the depositary bank, market prices of ADRs will be influenced not only by the performance of the company’s stock, but also by foreign currency exchange fluctuations.

Question 28

A customer owns 256 shares of ABC common stock. ABC declares a rights offering, with the terms being that for every 15 rights tendered, a shareholder may purchase one additional share at $24 per share. Any fractional rights holding may be rounded up to buy an additional share. If this shareholder wishes to subscribe, which statement is TRUE?

A.   The shareholder can buy a maximum of 15 shares by paying $360 
B.   The shareholder can buy a maximum of 16 shares by paying $384    C.   The shareholder can buy a maximum of 17 shares by paying $408    D.   The shareholder can buy a maximum of 18 shares by paying $432

Answer 28

The best answer is D.
The terms of the rights offering are that fractional holdings are rounded up to buy 1 additional share. This person owns 256 shares and thus, will receive 256 rights. 256 rights / 15 rights per share = 17.06 shares, which is rounded up to 18 shares @ $24 each = $432 necessary to subscribe.