Module 3: Equity Investments and Managed Assets Flashcards
Bondholder vs Stockholder
Shareholders have proportionate shares of the assets and earnings of the corporation.
Bondholder is entitled to a fixed rate of payment and a return of principal but does not have an ownership.
Bondholders do have a right, above that of stockholders, to the corporation’s assets in the event of default or liquidation.
Equity disadvantage
not tax deductible for income tax purposes but bond interest is.
Common stock
units of ownership in a publicly traded corporation
stock’s par value
dollar per share and has no economic meaning in terms of actual value.
Blue-chip stocks
highly regarded, well capitalized companies. Historically paid dividends regardless of the economy.
Growth stocks
Companies that have sales and earnings growth rates exceeding those of the average company in their industry.
Do not pay dividends; they invest their earnings back into the company.
Emerging growth
smaller and younger growth companies, that survived the early years and are just beginning to grow and expand. Emerging growth stocks great potential for investment, but subject to tremendous risk.
Income stocks
stocks issued that pay regular, consistent dividends and provide current income for investors. Ex: Stock issued by a utility company. Often in the maturity phase of the industry life cycle.
Value Stocks
Trade at low prices, given the historical earnings and asset values. Value investment managers attempt to find these high-quality companies that are temporarily undervalued by the market in hopes that the market will recognize their true value and their price will increase.
Growth stocks can become value stocks.
Cyclical stocks
stocks that prosper in a growing economy and tend to do poorly during declining economic conditions (e.g., automobile manufacturers, consumer discretionary companies, and restaurants).
If economy is growing, demand strengthens and companies make large profits. If economy is in a downturn, companies hurt by decline in demand and are less profitable.
Defensive stocks
Stocks unaffected by the business cycle (e.g., grocery chains). Have steady (although slow) growth, popular during economic recessions, and lose popularity in economic booms. Provide products that are necessary for everyday life. The demand for these products are not adversely affected by changing economic cycles.
Technology Stocks
Part of broader technology sector. Relates to research, development, and distribution of products. Include companies involved in electronics, data storage, computer software, robotics, and life science.
Market Risk
Changes in the market to influence the prices of equities. When the market rises, stocks increase in value. Stocks fall with a declines in the market. A move in the market is by change in economic environment.
Interest Rate Risk
Interest rates rise, there is negative pressure on the value of common stocks; when interest rates fall, stocks tend to increase in value.
Business Risk
Speculative nature of the business, the management of the business, and the philosophy of the business
Financial Risk
Firms method to acquire assets is directly related to financial risk or financial leverage. With regard to capital structure, companies may use debt through the issuance of bonds, or they may issue equity securities. When companies choose debt to finance the purchase of additional assets, it increases the level of financial risk.
capital gain or loss
Gain/Loss = net sales price - shareholder’s basis in the shares
Rights
Rights are a purchase option for stock that allows a shareholder the opportunity to buy shares of the new stock issue, thereby maintaining the overall percentage ownership in the corporation.
- Short Term
- On issuance, exercise price below market price
- issued by a corporation to raise funds by issuing new stock to public.
- Current shareholder is given one right for each share of stock
- Stockholders offered rights, purchase company’s common stock below current market price.
Warrants
Long-term, customized call options
On issuance, exercise price higher than market price
For a small premium, guarantees the opportunity to buy stock at a fixed price during a period. (higher than current market price)
sweetener or equity kicker, making the issue more attractive
Warrants vs Call Options
Warrant is issued by a corporation
Call is written by an individual.
Warrant is customized
Call is standardized terms
Warrant has maturity date (five years or more)
Call expires within nine months
Warrant Profit Formula
Profit = (gain on stock - cost of warrant) x number of shares
Dividend
Declared on common (or preferred) stock by board of directors before any realized income.
A bonds is a guaranteed payment.
Not all shareholders receive dividends; only shareholders of record.
shareholder of record
owner listed on the record date.
Record Date
The first business day after the ex-dividend date.
On record date, trades are settled and reflected on the corporation’s books.
To be listed as a shareholder of record, the investor must purchase stock before the ex-dividend date.
Ex-dividend date
The first day a stock is traded without the buyer being eligible to receive a previously announced dividend.
EX: If 10/2/2023 is record date, when would investor purchased stock to received declared dividend? Sept. 30th.
Who receives dividends first, preferred stockholders or common stockholders?
Preferred Stockholders.
Common shareholders claim on residual earnings after bondholders and preferred stockholders are paid. Hopefully their dividends increase as the company’s earnings increase, a major attraction to owning common stock.
Some dividend-paying companies aim to pay a common stock dividend that is a set percentage of earnings.
Dividend Payout Ratio
Company’s earnings/share = $2.00
The company pays 30% of its earnings as a dividend.
Payout Ratio = 30% of $2.00, or $0.60, per share to common stockholders.
Dividend Reinvestment Plans (DRIPs)
purchase add’l stock using cash dividends, paying little or no commission and at a discount to market price.
Buy and hold progra, benefits of dollar cost averaging
DRIP income tax purposes
Unlike cash dividends, the amount of reinvested dividends adds to the investor’s tax basis.
Taxation of Cash Dividends
Qualified and qualified corporate dividends are permitted preferential tax treatment.
Corporations whose stock of American depositary receipts is readily tradable on an established U.S. securities market also qualify.
Nonqualified dividends are taxed at the ordinary income tax rate.
Qualified dividend income may be treated at favorable long-term capital gain rates (0%, 15%, or 20%) if it meets the following criteria
Dividend received is a domestic corp or qualified foreign corp.
Stock held for greater than 60 days during 121-day period beginning 60 days before the ex-dividend date.
*Dividends declared by a corporate board of directors of a domestic corporation are qualifying dividends
Stock Dividends
Additional shares of company stock rather than in cash.
When stock dividend declared and paid, value of common stockholders share is reduced (price of stock decreases on a basis relative to stock dividend).
When does Dilution occur
when a company issues a stock dividend in place of a cash dividend.
Stock Splits
Par value/share is reduced and number of shares is increased proportionately.
Companies split stock to reduce stock’s market price/share, making it more attractive to smaller investors. Resulting in an increase of total shares outstanding.
Still own same percentage
Never income taxable, basis per share is adjusted downward
Reverse stock split
Company reduces total shares outstanding to increase the price of the outstanding shares, making the company less likely to be delisted by an exchange and more attractive to potential investors.
Open-End Investment Company
(mutual fund)
Type of investment company.
Popular for small/individual investors.
Pool capital from investors and invest in stocks, bonds, money market instruments.
Categorized as open end because unlimited # of shares sold to investors.
prospectus
Contains important information about investment company fees and expenses, investment objectives, strategies, risks, performance, pricing, and more.
net asset value (NAV)
Calculated everyday because purchase (buys) and redemption (sell) prices are based on the NAV
Formula for Funds Total Net Asset Value (NAV)
Funds total NAV = assets (cash + current value of securities) − liabilities
Formula for Total Net Asset Value (NAV) Per Share
Nav/share = funds nav / # shares outstanding
mutual funds charge a sales commission referred to as
sales load
Front-end load (Class A shares)
Shares have commission added to cost of shares.
Have a lower total cost structure than other classes, making it suitable for long-term investment horizons.
Back-end load (Class B shares)
(aka contingent deferred sales charge (CDSC))
Assesses shares if investor sells within a certain time of purchase. The contingent deferred sales charge may be waived after holding the shares five years or longer.
Level-load fund (Class C shares)
Asset based
Uses the annual 12b-1 fee as a sales charge.
Management Fee
(Mutual fund operating expense)
Paid by a mutual fund to investment advisor for services relating to managing the fund (salaries of the portfolio manager(s), analysts, and other related research expenses.
