Unit 1 | Types & Characteristics Of Equity Securities Flashcards
- Owners of a corporation’s equity securities
A. are always assured dividends if the company is profitable.
B. are creditors of the corporation.
C. have limited liability.
D. have the right to vote their shares.
- C | One of the benefits of being an owner of a corporation’s equity securities is limited liability. That means, no matter what happens to the company’s fortunes, the investor can never lose more than the original investment.
The company’s creditors cannot come after the stockholders and make a claim. Although owners of common stock always have voting rights, owners of preferred stock (the other equity security) almost never do. Dividends are not guaranteed, and even if the company shows a large profit, there is no obligation to make a dividend payment. Remember, as holder of a company’s equity securities, one is an owner, not a creditor.
LO 1.a
- Among the benefits of owning common stock are
I. historical hedging against inflation.
II. voting rights.
III. access, as owners, to information about corporate earnings before the genes
public.
IV. dividends,
A. I and II
B. I, II and IV
C. Il and IV
D. I, II, III, and IV
- B | One does not have access to insider information solely by becoming a shareholder.
Even if one did receive material nonpublic information, such as prior access to earnings, no benefit may be received from that information. All of the other choices are among the reasons to purchase common stock.
LO 1.b
- A company that has issued cumulative preferred stock
A. pays past and current preferred dividends before paying dividends on common stock.
B. pays the preferred dividend before paying the coupons due on its outstanding bonds.
C. pays the current dividends on the preferred, but not the past dividends on the preferred, before paying a dividend on the common.
D. forces conversion of the preferred that is trading at a discount to par, thereby eliminating the need to pay past-due dividends.
- A | The concept behind cumulative preferred stock is that dividends in arrears “accumulate” and must be paid, along with the current year’s dividend, before anything can be paid to common stockholders. Bond interest is always paid before dividends.
LO 1.c
An investor owns 15% of the stock of a publicly traded company. This investor’s spouse owns 5% of the stock of the same company. If the spouse wishes to sell the shares representing that 5% ownership, which of the following statements are true?
I. Both the investor and the spouse are control persons.
II. The investor is a control person, while the spouse is not.
III. The spouse must file a Form 144.
IV. The investor must file a Form 144.
A. I and Ill
B. I and IV
C. II and III
D. Il and IV
A. The investor’s 15% ownership is evidence of control status. Rule 144 includes in the definition of control person “Any relative or spouse of such person, or any relative of such spouse, any one of whom has the same home as such person.” Unless otherwise stated, the assumption on the exam is that spouses reside together, making both control persons. All sales of control stock (unless an exemption applies) must be accompanied by a Rule 144 filing on Form 144 by the selling party. Although both are control persons, the spouse is the only one selling and, therefore, is the one required to file.
- Four years ago, Susan was granted enough nonqualified stock options (NQSOs) to purchase 500 shares of her employer’s stock at $20 per share. Assuming Susan exercises all of her options when the fair market value of the stock is $30 per share and her ordinary income tax rate at the time is 28%, how much income tax will be due?
A. $280
B. $1,400
C. $5,600
D. $8,400
B | The exercise cost of the NQSO is $10,000
(500 shares × $20 per share). She will have to pay ordinary income taxes of $1,400 on the bargain element: ($30 FMV - $20 exercise price) × 500 shares x 28%. In addition, that $10,000 will also be subject to the same taxes as her regular salary, e.g., Social Security tax.
LO 1.d
- Which of the following statements about restricted stock is correct?
A. It must be held a minimum of one year before resale.
B. Sales must be accompanied by Form R.
C. Volume limits generally apply to sales by control (affiliated) persons.
D. The restrictions apply only to those defined as control persons.
- C | All purchasers of restricted stock generally have a holding period requirement of six months, not one year. When reselling that stock, the sale must be accompanied by Form 144. Once the six months are over, nonaffiliated persons have no further restrictions, while control (affiliates) generally have a volume limit.
LO 1.e
- ADRs are used to facilitate
A. foreign trading of domestic securities.
B. foreign trading of U.S. government securities.
C. domestic trading of U.S. government securities.
D. domestic trading of foreign securities.
D | Because everything is in U.S. dollars and in English, ADRs make trading in foreign securities much easier for those who live in the U.S.
LO 1.f
- Which two of the following risks would be of greatest concern to the holder of an
ADR?
I. Currency
II. Liquidity
III. Market
IV. Purchasing power
A. I and lI
B. I and III
C. Il and IV
D. Ill and IV
B | ADRs represent ownership in a foreign security so there is always going to be currency risk (I). These ADRs trade in the market and have market risk (III). Because most ADRs are traded on the exchanges, there is little liquidity risk and, because they represent equity, they are usually a good hedge against inflation.
LO 1.f
