Unit 1: Types and Characteristics of Equity Securities: EQUITY SECURITIES

Question 1

Introduction:

The investment world is divided between…

Answer 1

owners (stock, or equity securities) and lenders
(bonds, or debt securities).

Question 2

Introduction:

(A) is perhaps the most visible and accessible means by which wealth is created.

Answer 2

Owning equity in a company

Question 3

Introduction:

Individual investors buy stocks to…

Answer 3

own a piece of a company, benefiting from its growth and often earning dividends.

Question 4

Characteristics of Equity Securities:

Define “Security” (noun).

Answer 4

an investment that represents either an ownership stake or a debt stake.

Question 5

Characteristics of Equity Securities:

When an investor buys shares of the company’s stock, they become…

Answer 5

becomes part owner in a corporation

Question 6

Characteristics of Equity Securities:

A debt security is usually acquired by…

Answer 6

buying an issuer’s a corporation or a government) bonds.

Question 7

Characteristics of Equity Securities:

A debt investment is a loan to the issuer in exchange for…

Answer 7

interest income and the promise to repay the loan at a future maturity date

Question 8

Characteristics of Equity Securities:

A debt investment does not confer…

Answer 8

ownership (equity) like you would get when you purchase a stock.

Question 9

Characteristics of Equity Securities:

When investors become owners of a corporation by purchasing stock in that company, they can…

Answer 9

Benefit from company prosperity by earning dividends and, especially with common stock, from share price increases.

Question 10

Characteristics of Equity Securities: Common Stock

Common stock is…

Answer 10

equity (ownership) in a corporation.

Question 11

Characteristics of Equity Securities: Common Stock

A company issues stock to…

Answer 11

raise capital

Question 12

Characteristics of Equity Securities: Common Stock

Investors who buy the stock are buying

Answer 12

a share of ownership in the company

Question 13

Characteristics of Equity Securities: Common Stock

Whatever a business owns (its assets) less its creditors’ claims (its liabilities) is the

Answer 13

net worth of the enterprise and belongs to the owners (its stockholders).

Question 14

Characteristics of Equity Securities: Common Stock

Each share of stock entitles its owner to (2 things)

Answer 14

1. a portion of the company’s earnings and dividends and
2. a proportionate vote in major management decisions.

Question 15

Characteristics of Equity Securities: Common Stock

Most corporations are organized so that common stockholders…

Answer 15

elect a board of directors who oversee company affairs. This allows stockholders to influence management decisions without being involved in daily operations.

Question 16

Characteristics of Equity Securities: Common Stock

The two types of stock that corporations may issue are…

Answer 16

common and preferred

Question 17

Characteristics of Equity Securities: Common Stock

When speaking of stocks, people generally mean…

Answer 17

common stock

Question 18

Characteristics of Equity Securities: Common Stock

Preferred stock also represents equity (ownership) in a corporation but usually does not have…

Answer 18

the same voting rights or appreciation potential as common stock.

Question 19

Characteristics of Equity Securities: Preferred Stock

Preferred stock normally pays

Answer 19

Preferred stock pays a regular fixed dividend, typically quarterly, and has priority over common stock. This means preferred shareholders must be paid dividends before common stockholders, and in bankruptcy, preferred shareholders have first rights to remaining assets.

Question 20

Characteristics of Equity Securities: Preferred Stock

Preferred stock is an equity security because it…

Answer 20

represents a class of ownership in the issuing
corporation.

Question 21

Characteristics of Equity Securities: Preferred Stock

The rate of return on a preferred stock is

Answer 21

fixed rather than subject to variation as with common stock.

Question 22

Characteristics of Equity Securities: Preferred Stock

Because of Interest rate Risk, or Money rate risk, the price of Preferred Stock usually changes with…

Answer 22

interest rates rather than the company’s business outlook, unless significant changes affect dividend payments.

Question 23

Characteristics of Equity Securities: Preferred Stock

All stockholders (even preferred stockholders), not creditors, are owners of a corporation. When it comes to bonds, regardless of the nature of the owner, it is always a…

Answer 23

debt security, and that makes the owners creditors.

Question 24

Common Stock Features: Growth (Capital Gains)

An increase in the market price of securities is…

Answer 24

capital appreciation

Question 25

Common Stock Features: Growth (Capital Gains)

Historically, owning common stock has provided investors with returns (A).

Most investors with a long-term investment horizon have included common stock in their portfolios to serve as (B), but stock prices can decline, particularly (C).

Answer 25

A. in excess of the inflation rate

B. hedge against inflation

C. over the short run

Question 26

Common Stock Features: Income

Many corporations pay (A) to stockholders. For common stockholders, these can grow (B).

Answer 26

A. regular quarterly cash dividends

B. over time with company profitability

Question 27

Common Stock Features: Income

Dividends are a crucial source of investor income and a key reason why (A).

Dividends are decided by (B).

Are dividends mandatory? (C)

Answer 27

A. many invest in stocks

B. the company’s board of directors

C. No.

Question 28

Common Stock Features: Income

Companies may also distribute two types of dividends:

Answer 28

1. stock dividends (additional shares of their own stock) or
2. property dividends (shares in subsidiaries or company products).

Question 29

Common Stock Features: Income

A corporation may pay common stockholders with (A) instead of cash.

Answer 29

A. additional shares, saving money that would normally be used for dividends

For instance, if an investor owns 100 shares and the company declares a 20% stock dividend, they receive 20 extra shares, making a total of 120 shares.

Question 30

Common Stock Features: Income

The stock price typically adjusts after a stock dividend to…

Answer 30

maintain the total value.

For example, if the pre-dividend price was $48 per share, the investor’s total stock value remains around $4,800 after receiving 120 shares, making each share approximately $40.

Question 31

Common Stock Features: Income

Two things about stock dividends:

(A) is related to tax.

(B) is related to cost.

Answer 31

A. they are tax-deferred until sold

B. they lower the investor’s cost basis per share.

Question 32

Common Stock Features: Income

Remember, a stock dividend differs from a stock split, which (A).

Answer 32

increases the number of shares without changing the overall value.

Question 33

Common Stock Features: Rights of Stockholders

How often can common stockholders vote for the corporation’s board of directors?

Answer 33

annually

Question 34

Common Stock Features: Rights of Stockholders

Regarding transferability, common and preferred stock are (A).

When transferring ownership, similar to selling a car, (B) is sent to the issuer’s transfer agent to issue a new certificate in the new owner’s name.

Because of this, transfer agents, typically large banks, must be SEC-registered to…

Answer 34

A. freely transferable without company permission

B. the stock certificate

C. prevent fraud

Question 35

Common Stock Features: Rights of Stockholders

Shareholders receive audited…

Answer 35

annual financial statements (annual reports)

Question 36

Common Stock Features: Rights of Stockholders

Common stockholders often have preemptive rights to…

Answer 36

maintain their ownership share, ensuring they can buy new shares before others.

Question 37

Common Stock Features: Rights of Stockholders

Preferred stockholders have no right to (A). However, they do receive (B).

Answer 37

A. maintain a percentage of ownership when new shares are issued (no preemptive rights).

B. preference in dividend payment and company liquidation.

Question 38

Common Stock Features: Limited Liability

One of the key benefits of owning stocks (common or preferred) is (A).

If a corporation goes bankrupt and cannot cover its debts with its assets, (B).

For instance, an investor putting $5,000 into a bankrupt company may lose their entire investment, but (C).

Answer 38

A. limited liability

B. shareholders are not personally responsible

C. they won’t have to use personal assets to pay off the company’s debts

Question 39

Common Stock Features: Liquidated

Regarding sale of common and preferred stocks, these securities are (A).

This is particularly true for stocks listed on major exchanges.

The sale of restricted stock requires (B).

Answer 39

A. generally easy to sell because they can be freely traded without needing permission from the issuer or others.

B. compliance with SEC Rule 144 before it can be sold

Question 40

Common Stock Features: Benefits and Risks of Owning It

In summation, why would you include common stock in a client’s portfolio? (3 things)

Answer 40

Potential capital appreciation
Income from dividends
Hedge against inflation

Question 41

Common Stock Features: Benefits and Risks of Owning It

What are the main risks of owning Common Stock? (3 total)

Answer 41

Market Risk: The price of common stock can decline, fluctuating daily based on perceptions of the company’s business prospects. There’s no guarantee investors can recover their investment.

Business Risk: The company’s earnings might decline, potentially reducing or eliminating dividends.

Low Priority at Dissolution: In bankruptcy, bondholders and preferred stockholders are paid before common stockholders, who have residual rights to corporate assets.

Question 42

Different Types of Preferred Stock:

All Preferred Stock:
Maintains preference over (A).

(B) at the discretion of the board.

Considered a fixed-income investment due to (C).

Dividends must be paid to (D).

Answer 42

A. common stock
B. Dividends are paid
C. fixed dividends, stated as an amount or percentage of par value.
D. preferred stockholders before common stockholders.