Unit 1

Question 1

A certificate issued by a company granting its owner the right to purchase securities from the issuer at some specified price years into the future would best be described as

Answer 1

a warrant A rights certificate is a very short-term security that grants the holder the right to buy the common stock of the company at a price lower than the current market price. A warrant is a long-term security that grants its owner the right to purchase securities from the issuer at a specified price that is higher than the current market price at the time the warrants are issued and at some point, in the future. Note that while the exercise price is higher than the current market value when the warrants are issued, it is hoped that the exercise price will be below current market value when the warrants are eventually exercised.

Question 2

A company has distributed profits to its shareholders. This type of distribution would most likely be in the form of

Answer 2

dividends. The distribution of profits to shareholders would generally be in the form of dividends to be received at the discretion of the board of directors (BOD). Bonds and warrants are other types of securities a company might issue, while options are a derivative product that would not be issued by the company. LO 1.e

Question 3

A corporation that has issued cumulative preferred stock

Answer 3

pays past and current preferred dividends before paying dividends on common stock. Dividends in arrears (those missed) on cumulative preferred have the highest priority of dividends to be paid. Current and unpaid past dividends on cumulative preferred stock must be paid before common stockholders can receive a dividend. Bond interest, however, is always paid before any dividends, preferred or common. LO 1.i

Question 4

A corporation with 1 million shares of stock outstanding wishes to sell another 250,000 shares. When management conducts a rights offering, a shareholder owning 100 shares will be given stock rights to purchase how many additional shares?

Answer 4

25 shares Stock rights (also known as preemptive rights or subscription rights) give current shareholders the ability to preemptively purchase enough shares to maintain their proportionate ownership of the corporation. This prevents their dividend and voting power from being diluted. The shares outstanding in this case will go from 1,000,000 to 1,250,000. This investor must thus go from owning 100 shares out of 1,000,000 to 125 shares out of 1,250,000. This would require that the investor be able to purchase an additional 25 shares. LO 1.f

Question 5

A customer has held an account with a broker-dealer for over one year. A registered representative associated with the firm recommends the purchase of an unlisted security trading at $3.50. What documentation, if any, is required prior to the trade?

Answer 5

A disclosure statement is required, but not a suitability statement. Established customers are exempt from the suitability statement requirement but not from the disclosure requirements when penny stocks are being solicited. An established customer is someone who has held an account with the broker-dealer for at least one year (and has made a deposit of funds or securities); or has made at least three penny stock purchases of different issuers on different days. LO 1.c

Question 6

A customer owns cumulative preferred stock (par value of $100) that pays an 8% dividend. The dividend has not been paid this year and was missed in the two previous years. If the company wants to pay a dividend to common shareholders, how much must the company pay this customer per share first?

Answer 6

$24 If the company is going to pay a common stock dividend, it must pay the preferred dividends first, including all dividends in arrears (missed). There are $16 due in back dividends for the two years missed, in addition to $8 this year, for a total of $24.

Question 7

A penny stock is best described as

Answer 7

an unlisted stock valued at less than $5 per share. A penny stock is an unlisted (not listed on a U.S. stock exchange) security offered at less than $5 per share. LO 1.c

Question 8

A preferred shareholder’s priority claim on assets is the preferred shareholder’s priority standing over

Answer 8

common shareholders. A preferred shareholders priority claim on assets is the preferred shareholders priority standing over common shareholders only. Employees of the corporation, debt (bond) holders and other creditors would all have claims on assets settled before preferred shareholders. LO 1.i

Question 9

A preferred stock dividend is stated as a percentage of.

Answer 9

par value. A preferred stock dividend is stated as a percentage of its par value, which is assumed as $100 for preferred shares, unless it has been stated differently.

Question 10

A shareholder feels strongly about some of the issues to be voted on at the next shareholder meeting but is unable to attend. Which of the following is true?

Answer 10

The shareholder can vote by proxy. If unable to attend a shareholder meeting, shareholders can vote by an absentee ballot, known as a proxy. Delivery of the proxy can be made online or by mail. LO 1.e

Question 11

A shareholder owns preferred shares that allow for the possibility of receiving more than the stated dividend. This type of preferred share would be known as

Answer 11

participating. In addition to the fixed stated dividend, participating preferred stock offers its owners the possibility of receiving a share of corporate profits that remain after all dividends and interest due other securities are paid. LO 1.i

Question 12

All of the following are considered control persons (owning control stock) except

Answer 12

an unaffiliated shareholder owning 8% of the outstanding shares. By virtue of their positions, directors and officers are considered control persons and any stock they own, no matter how little, is considered control stock. To be considered a control person, an unaffiliated person would have to own 10% or more of the voting (outstanding) shares. LO 1.g

Question 13

All of the following could be characterized as benefits to owning common stock except.

Answer 13

low dissolution priority. Low dissolution priority refers to being paid last in the event of a corporate dissolution (bankruptcy). Obviously, this is not a benefit. However, price appreciation and the receipt of dividends are potential benefits and limited liability is guaranteed, only being able to lose what one has invested. LO 1.e

Question 14

An individual owning shares of a corporation’s common stock would have all of the following rights except

Answer 14

to declare dividends. Common shareholders have a number of rights. While they may receive dividends, declaring dividends is a function of the BOD. LO 1.c

Question 15

An investor has just received stock rights in the mail allowing the purchase of 250 shares of a stock offering at a discount. With these rights, the investor may take any of the following actions except.

Answer 15

purchase 125 shares at double the discount. Once an investor has received stock rights, the rights may be exercised in whole or in part, sold on the open market in whole or in part, allowed to expire in whole or in part, or some combination of these. The discount, however, stands as offered and may not be manipulated.

Question 16

An investor interested in quarterly income should invest in

Answer 16

utility company stock. Utility stocks generally pay quarterly dividends, whereas corporate and Treasury bonds pay interest semiannually. STRIPS pay at maturity. LO 1.d

Question 17

An investor needs to decide whether or not they would like to maintain their percentage of ownership in a company that has decided to increase the number of outstanding shares. Which of the following is the best description of what is taking place?

Answer 17

Rights will be distributed to existing stockholders with an exercise price lower than the current market value. Preemptive rights entitle existing common stockholders to maintain their proportionate ownership shares in a company by buying newly issued shares before the company offers them to the general public. They are offered with an exercise price lower than the current market value and are issued (typically) for a period of four to six weeks (30–45 days). Existing shareholders who receive rights have three options: they may be exercised, sold in the secondary market, or allowed to expire at the end of their subscription. LO 1.f

Question 18

An investor would expect which type of preferred stock to pay the highest stated dividend rate?

Answer 18

Callable With callable preferred stock, to compensate for the possibility that the shares may be called, the issuer pays a higher dividend than with straight preferred. Cumulative and convertible preferred have positive characteristics that would justify a lower fixed dividend than straight. LO 1.i

Question 19

An officer of a public company buys 1,000 shares of the company’s registered stock in the open market. Regarding the sale of these shares, the officer may sell

Answer 19

immediately, subject to Rule 144 volume limitations. Because the shares were purchased in the open market (already registered), the transaction is not a private placement and there is no required holding period. The officer, however, is an affiliate and is therefore subject to the reporting and volume limitations imposed when selling under Rule 144.

Question 20

By purchasing shares of stock in a company, investors can benefit from which of the following? An increase in the price of the shares The receipt of profits to be distributed

Answer 20

I and IV Stockholders as owners can benefit from an increase in the price of the shares (capital appreciation) and by sharing in earnings through the receipt of dividends (distributed profits). Both are potential benefits, but neither are guaranteed. LO 1.e

Question 21

Common shareholders have the right to receive an audited set of financial statements of the company’s performance

Answer 21

annually While a company can supply this information as often as they want to shareholders, it is only required that an audited report be received on an annual basis. LO 1.c

Question 22

Common stockholders owning dividend paying stocks are exposed to

Answer 22

market risk and current income risk. In owning common shares, the investor stands to lose current income through dividend reduction or suspension (current income risk), as well as capital loss, should the market price decline (market risk). LO 1.d

Question 23

DEF Corporation has 4% noncumulative preferred stock outstanding. The company eliminated its dividend payments for the past three years but now is in a position to resume paying them again. Before paying common shareholders a dividend, the company would be required to pay the preferred shareholders

Answer 23

$4.00. With noncumulative preferred stock, missed or skipped dividends need not be paid or made up. However, in order to pay common shareholders in any year, preferred shareholders must receive their full dividend for that year. While it can be paid in one annual payment, quarterly, or however the board approves it to be paid, the total in this case would be $4.00. 4% × $100 par value = $4.00. LO 1.i

Question 24

During times when interest rates are rising, which of the following preferred are likely to pay a higher annual dividend?

Answer 24

Adjustable rate Adjustable-rate preferred dividends are tied to benchmark interest rates such as Treasury securities. As these rates fluctuate up and down, so do the dividends on the adjustable shares. LO 1.i

Question 25

Exempt from the penny stock rules are

Answer 25

unsolicited transactions. Unsolicited transactions (those not recommended by the broker-dealer or registered representative) are exempt from the penny stock rules. Solicited transactions are nonexempt and the rules therefore apply. LO 1.c

Question 26

For restricted stock (unregistered) held by a nonaffiliated, which of the following applies?

Answer 26

Six-month holding period, with sales allowed freely thereafter. For restricted stock (unregistered) held by a nonaffiliated, a six-month holding period before any sales can be made applies. After the holding period, sales can be made freely.

Question 27

LMN Corporation has a $60 par, 4% preferred stock currently trading at $45 per share. Its annual dividend is

Answer 27

$2.40. For preferred shares, the annual dividend is stated as a percentage of par. In this case, 4% of par value of $60 equals $2.40.

Question 28

MMS Corporation has 7% callable preferred shares outstanding. Over the past few years, benchmark interest rates have declined and hovered close to 3%. Which of the following is true?

Answer 28

The 7% shares are likely to be called. When interest rates fall, callable preferred shares are likely to be called. This allows the issuer to cease the higher dividend payments and reissue shares with lower dividend payments that align more with the current interest-rate environment. With interest rates now at 3%, the issuer would have no desire to issue more 7% shares, nor could they reduce the fixed dividend on these 7% shares. If the shares were convertible, conversion would be at the discretion of the shareholders, not the issuer. LO 1.i

Question 29

Mr. Smith bought an American depository receipt (ADR) in a French company at $13.03 and recently sold the shares for $24.88. How would this trading profit be taxed?

Answer 29

The profit is taxed as a capital gain in the United States only. Any trading profits (capital gains) from an ADR would only be taxable here in the United States. A capital gain is the profit realized when buying then selling the shares. Remember, dividends paid to a U.S. investor may be subject to a withholding tax by the home country of the underlying foreign stock issuer. In many cases, the amount of tax withheld by the foreign government is applied as a credit against the investor’s U.S. tax liability. LO 1.h

Question 30

Of the following stocks, which would be defined as penny stocks? Bulletin Board stock trading at $4 per share OTC Pink stock trading at $4 per share

Answer 30

Bulletin Board stock trading at $4 per share OTC Pink stock trading at $4 per share A penny stock is a non-Nasdaq listed (therefore, Bulletin Board or OTC Pink) stock trading under $5 per share. If a stock is listed on an exchange or listed on Nasdaq, it is not a penny stock, regardless of price. LO 1.c

Question 31

Once a dividend is initially declared by the board of directors (BODs), any future dividend payments

Answer 31

carry no guarantee of payment in any amount. While the potential to share in the company’s profits by receiving dividends is considered one of the benefits of equity ownership, one of the risks is the possibility of dividend income decreasing or ceasing entirely. Dividends are not guaranteed in any way. LO 1.d

Question 32

Penny stock rules

Answer 32

specify that established customers of the firm need not sign a suitability statement. require that prospects be given a copy of a risk disclosure document before their initial penny stock transaction.

Question 33

Preferred shareholders who expect missed dividend payments to be eventually paid are most likely to own

Answer 33

cumulative preferred stock. Cumulative preferred stock accrues payments due its shareholders that have been missed in the event dividends are reduced or suspended. LO 1.i

Question 34

Preferred shares have

Answer 34

characteristics of both equity and debt securities. Preferred shares are equity securities, but not only do they have the characteristics of equity securities, they share some of the characteristics of debt securities as well. The most notable characteristic is that a preferred stock’s annual dividend represents its fixed rate of return, like the fixed rate of return for a bond (debt security).

Question 35

Regarding investment products, which of the following is true?

Answer 35

Equity securities represent ownership in an issuing company. Equity securities represent ownership in an issuing company and debt securities represent a loan to the issuing company, but derivative products, such as options, represent neither.

Question 36

Regarding preferred stock, all of the following are true except

Answer 36

a corporation issuing common shares must issue at least one class of preferred shares. No corporation is required to issue any class of preferred stock. Preferred shareholders have no voting rights or preemptive rights but are paid before common shareholders in the event of a corporate dissolution. LO 1.i

Question 37

Regarding the rights of a common stockholder, each of the following is true except

Answer 37

stockholders may never be part of the management of the company. While stockholders have a voice in how the company is run, that voice is exercised through their vote for those who serve on the board of directors. Essentially, by electing a board of directors, stockholders have a say in the company’s management but are not involved in the day-to-day details of its operations. However, there is no prohibition preventing a manager or director from owning stock in the company; their position is not directly related to their ownership of company stock. LO 1.c

Question 38

Restricted shares, those that are unregistered, meaning that they were not attained in a public offering, may be sold by a nonaffiliate.

Answer 38

after holding them for six months and freely thereafter. Nonaffiliates holding unregistered shares must wait six months before divesting of those shares, but because they are nonaffiliates, they may sell freely (without volume restrictions) thereafter. LO 1.g

Question 39

Rule 144 imposes volume limitations on the number of shares that can be sold by control persons selling registered stock held for one year. control persons selling restricted stock held for two years.

Answer 39

control persons selling registered stock held for one year. control persons selling restricted stock held for two years. Control persons are always subject to volume limitations. Nonaffiliates have no volume (or any other restrictions) when selling registered stock. If, however, the shares are restricted, volume limits for nonaffiliates are imposed for six months.

Question 40

Rule 144 stipulates that after holding restricted stock fully paid for six months, an affiliate may begin selling shares

Answer 40

subject to volume restrictions within any 90-day period. Rule 144 stipulates that after holding restricted stock fully paid for six months, an affiliate may begin selling shares but is subject to volume restrictions within any 90-day period. LO 1.g

Question 41

Rules to protect the public during initial public offerings (IPOs) include all of the following except.

Answer 41

shares may be held to reward others who can direct business to the member. Designed to protect the integrity of the public offering process, the rules ensure that members make a bona fide public offering of securities at the public offering price, do not withhold securities in a public offering for their own benefit or use shares to reward others in a position to direct future business to the member and that members and their associated persons do not take advantage of their insider status to gain access to new issues for their own benefit at the expense of public customers. Note that this is an “except” question. “Shares may be held to reward . . .” is not only not in the rule, it is expressly prohibited.

Question 42

Securities acquired through some means other than a registered public offering are known as

Answer 42

restricted Restricted securities are those acquired through some means other than a registered public offering. Securities purchased via a private placement are an example. These securities may not be sold (are restricted) until they have been held fully paid for six months. LO 1.g

Question 43

The decision to pay a dividend rests with

Answer 43

the board of directors (BOD) but is not guaranteed. The decision to pay a dividend rests with the BOD but is not guaranteed. The declaration to pay a dividend may or may not occur. When it does occur, the amount can decrease, increase, or remain unchanged from the previous dividend. LO 1.c

Question 44

The growth potential in the price of preferred shares is generally considered to be

Answer 44

less than that of the issuer’s common shares. While the growth potential of both common and preferred shares can be tied to a company’s financial well-being, preferred share growth is generally less than that of the common shares. The trade-off is that the preferred shares have preference with dividends received, enjoy a fixed rate of return via those dividends, and have a priority claim over common shareholders in the event of bankruptcy and the dissolution of assets. LO 1.i

Question 45

The potential that inflation will devalue the fixed dividend income payments received by preferred shareholders is known as

Answer 45

purchasing power risk. Remember that the fixed dividends received by preferred shareholders are a stated percentage of par value. Purchasing power risk is the possibility that the income produced via the fixed dividend received will not purchase as much in the future for preferred shareholders as it does today due to inflation. LO 1.i

Question 46

Transactions where the penny stock rules are applicable would be those that

Answer 46

are solicited. Unsolicited transactions (those not recommended by the broker-dealer or registered representative) are exempt from the penny stock rules. Solicited transactions are nonexempt, and the rules therefore apply. LO 1.c

Question 47

What is the primary purpose of an issuer sponsoring an American depository receipt (ADR)?

Answer 47

These securities are created to attract a U.S. investor base. ADRs are a type of equity security designed to simplify foreign investing for Americans. An ADR is created when common shares are purchased in the foreign company’s home market. These shares are then deposited in a foreign branch of a U.S. bank and a receipt (the ADR) is created. The ADR trades in the U.S and is denominated in U.S. currency making the process of buying a foreign stock much easier for an American investor. ADRs are subject to U.S. securities regulations.

Question 48

What is the tax status of a dividend paid to a U.S.-based American depository receipts (ADR) investor?

Answer 48

These dividends may be taxed by both the foreign country and the United States. Dividends paid to a U.S. investor may be subject to a withholding tax by the home country of the underlying foreign stock issuer. In many cases, the amount of tax withheld by the foreign government is applied as a credit against the investor’s U.S. tax liability. Note: Any trading profits (capital gains) from the ADR would only be taxable here in the United States. LO 1.h

Question 49

When shareholders owning participating preferred shares receive the additional participating amount, this was determined by

Answer 49

the board of directors (BOD). Additional dividends in profitable years payable to participating preferred shareholders is at the direction of the BOD. Just as a dividend is declared, the BOD would declare any participating dividend to be paid. LO 1.i

Question 50

When the board of directors (BOD) declares a dividend,

Answer 50

owners of preferred shares must be paid before any payment is made to common shareholders. When the BOD declares dividends, owners of preferred shares must be paid before any payment is made to common shareholders. This is known as the dividend preference allotted to preferred shareholders. There is no relationship between the amounts paid to preferred shareholders and common shareholders. LO 1.i

Question 51

Which of the following best describes the trade execution of American depository receipts (ADRs)?

Answer 51

Trades are executed domestically in U.S. dollars. ADRs are often listed on a securities exchange such as the NYSE or Nasdaq and trade throughout the day. Trades in these securities are dollar denominated. ADRs trade and settle in the same fashion as a traditional U.S.-based common stock. LO 1.h

Question 52

Which of the following features of preferred stock allows the holder to reduce the risk of inflation?

Answer 52

Convertible Fixed-dollar investments, such as bonds and preferred stock, are subject to inflation risk, which is the risk that the fixed interest or dividend payments will be worth less over time in terms of purchasing power. The ability to convert to common stock, which tends to keep pace with inflation, offsets this risk.

Question 53

Which of the following preferred stocks allows the issuer to pay the shareholders par and cease dividend payments following a stated period?

Answer 53

Callable The issuer can pay off callable preferred at any time after the call protection period, and dividends will cease. LO 1.i

Question 54

Which of the following securities is the underlying asset used to create an American depository receipt (ADR)?

Answer 54

Common shares ADRs are a type of equity security designed to simplify foreign investing for Americans. An ADR is created when common shares of a foreign issuer are purchased in the foreign company’s home market. These shares are then deposited in a foreign branch of a U.S. bank and a receipt (the ADR) is created. Each ADR may represent one or more shares of foreign-company stock held on deposit.

Question 55

Which of the following sell transactions is not subject to the holding period restriction specified in SEC Rule 144?

Answer 55

Stock acquired in the OTC market by a corporate affiliate The holding period rule applies only to unregistered stock, which may or may not be control stock. Unregistered stock results from either private placements or the exercise of a corporate stock option. Because this question asked which securities were not subject to the Rule 144 holding period, only stock acquired in the OTC market by a corporate affiliate is the correct answer. However, the affiliated person is subject to volume restrictions. LO 1.g

Question 56

Which of the following statements about rights and warrants is true?

Answer 56

Rights are short term; warrants are long term. A security with a termination, maturity, or expiration date that is one year or less from the date of issue is said to be short term. Rights offerings have a lifetime of four to six weeks, which makes them short term. If the end date is more than a year from the issue date, the security is long term. Warrants have expiration dates typically two to five years from the date of issue, which makes them long term. LO 1.f

Question 57

Which of the following statements is correct concerning the pricing of American depository receipts (ADRs)?

Answer 57

ADR pricing is dollar-based and fluctuates throughout the day. Many ADRs are listed on exchanges such as the NYSE or Nasdaq. ADRs trade throughout the day and settle in the same manner as would the shares of a U.S.-based company. ADRs are priced in U.S. dollars. LO 1.h

Question 58

Which of the following statements is correct concerning currency risk when investing in an American depository receipt (ADR)?

Answer 58

Currency risk is still a factor when purchasing an ADR. ADRs are issued and pay dividends in U.S. dollars eliminating the complications of currency conversion. However, ADRs are still subject to currency risk. Why? The company pays dividends in its home currency, and the issuing bank pays out those dividends in U.S. dollars. When the exchange rate changes, the amount these dividends (in U.S. dollar terms) will fluctuate as well. Also, the value of the ADR itself will rise and fall with the value of the underlying foreign stock which is partially due to currency swings.

Question 59

Which of the following preferred issues is most likely to fluctuate in line with the issuer’s common shares?

Answer 59

Convertible Convertible preferred shares can be converted into shares of the issuer’s common stock. In this light, the value of a convertible preferred stock is linked to the value of the common stock and the convertible preferred share price tends to fluctuate in line with the common.