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Questions and Answers to the Series 7 Exam

A corporation has issued $100 par, 8% cumulative convertible preferred stock, callable at par. The preferred is convertible into 1.4 shares of common stock. Currently, the preferred stock is trading at 102 while the common stock is trading at $75.50. The corporation calls the preferred stock at par plus accrued dividends of $2 per share.

If a customer buys 100 preferred shares, converts, and then sell the common stock in the market, the profit is?

a. $200
b. $320
c. $370
d. $570

Answer: C

If the customer buys 100 shares of the preferred stock, he will pay 100 x 102 per share = $10,200. Since each share of preferred is convertible into 1.4 common shares, the 100 preferred shares will be converted into 1.4 x 100 = 140 common shares. The sale of 140 common shares at the current market price of $75.50 will yield $10,570 - $10,200 = $370

Once the notice of call has been circulated, it can be expected that:

I. The number of common shares outstanding will remain the same
II. The number of common shares outstanding will increase
III. Earnings per common share will remain the same
IV. Earnings per common share will decrease

a. I and II
b. I and IV
c. II and III
d. II and IV

Answer: D

The economics of the situation are forcing preferred shareholders to convert to common. If the preferred shares are tendered at the call price, the owner receives $100 per share. If the preferred shares are sold at the current market price, the owner receives $102 per share. Since each preferred share is convertible into 1.4 common shares, if the preferred in converted and sold as 1.4 common shares, the holder will receive 1.4 x $75.50 = $105.70. Thus, converting is the most profitable choice. Once the preferred shareholders convert, the number of common shares outstanding will increase, causing earnings per share to be diluted.

A customer owns 20,000 shares of ABC common stock, ABC corporation has 2,000,000 shares outstanding. The company intends to sell an additional 100,000 shares through a rights offering. The customer will receive:

a. 1,000 rights to buy 2,000 shares
b. 2,000 rights to buy 1,000 shares
c. 10,000 rights to buy 2,000 shares
d. 20,000 rights to buy 1,000 shares

Answer D:

This shareholder owns 20,000 shares. In a rights distribution, 1 right is distributed for each share outstanding, so this shareholder will receive 20,000 rights. The corporation, which has 2,000,000 shares outstanding, intends to sell and additional 100,000 shares. A total of 2,000,000 rights will be issued to subscribe to 100,000 new shares. Thus, the terms of this offering will be that 2,000,000 rights/100,000 new shares = 20 rights needed to buy a new share. This shareholder will receive 20,000 rights. At 20 rights per share this entitles him to subscribe 1,000 (20,000/20 rights needed to buy 1 new share) new shares in the offering.

All of the following equity securities trade EXCEPT?

a. Common Stock
b. Preferred Stock
c. Treasury Stock
d. Common Stock Warrants

Answer: C

Treasury stock does not trade. It represents shares of the company that have been repurchased by the issuer. Such shares are held in "Treasury". Treasury stock does not vote, nor does it receive dividends. Issuers repurchase shares for Treasury typically to reduce the number of common shares outstanding. This increases reported Earnings per Share, and thus increases the common stock's market price. Common stock, preferred stock, warrants and rights all trade in the market.

A corporation is attempting to sell additional shares to its existing shareholders through a rights distribution. A shareholder who wishes to subscribe must send the purchase amount with the rights certificate to the:

a. transfer agent
b. standby underwriter
c. rights agent
d. corporate controller

Answer: C

A rights agent is hired to handle the mechanics of a rights offering. To subscribe, the existing shareholders submit their rights with the subscription dollar amount to the rights agent.

XYZ Company has issued 10%, $100 par non-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. 0
b. $5
c. $10
d. $15

Answer: C

Since the preferred stock is NON-cumulative to make a dividend distribution to common shareholders, the company need only make this year's preferred dividend distribution. The stated dividend rate on the preferred is 10% based on $100 par, so $10 of preferred dividends must be paid per share. If this preferred were cumulative, then all omitted dividends must be paid before a distribution can be made to common.

PDQ Company $10 par common stock is currently trading at $40. PDQ is currently paying a quarterly common dividend of $.90 per share. The current yield of PDQ stock is:

a. 2.25%
b. 4%
c. 9%
d. 10%

Answer: C

Yields are based on annual returns. This stock is paying a $.90 dividend quarterly, so the annual dividend rate is $3.60. The formula for current yield is:

Annual Income/Market Price = Current Yield

$3.60/$40 = 9%

Which of the following do NOT pay dividends?

I. Preferred Stock
II. ADRs
III. Warrants
IV. Real Estate Investment Trusts

a. I only
b. III only
c. III and IV
d. II and IV

Answer: B

Preferred stock pays a fixed divident rate; American Depository Receipt holders receive dividends; and REITs make divident distributions to hareholders. Holders of warrants and right do NOT receive dividends on these instruments

Corporate dividend payments can be made in all of the following ways EXCEPT?

a. cash or company products
b. additional common shares of that company
c. additional common shares of another company
d. listed options of that company

Answer: D

Corporations can pay dividends as cash and can also distribute products produced by that company as a dividend to shareholders.

Ex: P&G used to send soap products to shareholders. A company can make a distribution of additional shares of that company (a stock dividend); or issue a dividend consisting of shares of another company (typically a wholly owned subsidiary whose shares are distributed to owners of the parent company). Corporations can NOT make dividend distributions consisting of listed options in that company, since the contracts are created and issued by the Options Clearing Corporation - NOT the company.

All of the following statements about warrants are true EXCEPT?

a. Warrants have a longer term than rights
b. Warrants are issued to make corporate securities offers more attractive to investors.
c. Warrants give the holder a perpetual interest in the issuer's underlying common stock
d. Warrants trade separately from the stock of the company

Answer C

Warrants are long term options buy a company's shares at a fixed price. They are typically attached to debt and preferred stock offerings to make the securities more attractive to the purchasers. This is accomplished because the warrant gives growth potential to these senior security holders if the common stock price should rise in the future. Warrants typically have a fixed life of 5 years or less and then expires. Companies can issue perpetual warrants, but rarely do so.

Common stockholders have which of the following rights?

I. Right to vote for the Board of Directors
II. Right to vote for the annual dividend rate
III. Preemptive right
IV. Rights to corporate assets upon dissolution

a. I only
b. I and II
c. III and IV
d. I, III and IV

Answer: D

Common shareholders do not set the dividend rate - this decision is made by the Board of Directors of the company. Common shareholders do have the right to vote for the Board of Directors; the preemptive right to any new common shares that the company may issue; and the right to remaining corporate upon dissolution.

An ADR is?

a. US security held in US branches of foreign banks
b. foreign security held in foreign branches of US banks
c. negotiable certificate denominated in a foreign currency
d. negotiable certificate denominated

Answer: C

An ADR (American Depository Receipt) is a foreign security that is held in a foreign branch of a US bank. The bank issues receipts against these shares, and the receipts are registered in the US as securities and are listed and traded on US stock exchanges. In this manner, the foreign corporation does not have to register its shares with the SEC in order to have trading take place in the US.

Shareholder approval is required if a corporation wishes to make a:

a. Cash dividend distribution
b. Stock dividend distribution
c. Stock split
d. All of the above

Answer: C

The dividend decision is "discretionary" on the part of the Board of Directors of a company. Thus, no shareholder approval is required if a corporation wishes to pay a dividend, either in cash or in stock. Dividends are accounted for by taking the dividend amount out of retained earnings - it does not affect the stated par value per share. However, if a corporation wishes to split its stock, this changes the par value per share.
(Ex: a 2:1 stock split will doulbe the number of shares and reduce the par value in half).
Any par value change requires an amendment to the corporate charter and, in most states, this requires a shareholders vote.

The definition of Treasury stock is:

a. authorized shares minus issued shares
b. issued shares minus outstanding shares
c. authorized shares minus outstanding shares
d. capital in excess of par value minus par value

Answer: B

If a company has the same number of issued shares as the number of shares outstanding, then no shares have been repurchased for the company's Treasury. However, if the company repurchases shares, the number of outstanding shares decreases. Thus, the definition of Treasury stock is issued shares minus outstanding shares.

The transfer agent is typically responsible for all of the following functions EXCEPT?

a. maintaining the integrity of the record of all shareholder names and addresses
b. acting as disbursement agent for the corporation
c. issuing new stock certificates
d. cancelling old stock certificates

Answer: A

The transfer agent cancels old shares and issues new shares. It is the responsibility of the registrar to maintain the integrity of the shareholder list, and to insure that the number of shares transferred from one shareholder to another always matches. The transfer agent typically performs the role of paying agent as well. When a corporation makes a distribution, the paying agent actually prepares and mails the checks.

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 the 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: B

Under CUMULATIVE voting, shareholders can accumulate their votes and place them on any directorship (or combination of directorships). Therefore, 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 a few) directors, and by virtue of the extra weight of those votes, get the director elected.

During a period of stable interest rates, which type of preferred stock would show the greatest price volatility?

a. Cumulative
b. Convertible
c. Participating
d. Callable

Answer: C

Preferred stock is interest rate sensitive since it is a fixed income security. As market interest rates rise, preferred stock prices fall. As market interest rates fall, preferred stock prices rise. If market interest rates are stable, preferred stock (and bond) prices, should be stable as well. However, participating preferred stock gives the preferred participation in any extra dividends declared by the company to its common shareholders. Thus, the declaration of such an extra dividend would make the preferred stock more valuable and its price would go up in the market - and this did not happen because market interest rates fell.

Which statements are true regarding ADRs?

I. Dividends are declared in US dollars
II. Dividends are declared in the foreign currency
III. Receipt holders receive dividend payments in US dollars
IV. Receipt holder receive dividend payments in the foreign currency

a. I and III
b. I and IV
c. II and III
d. II and IV

Answer: C

The foreign corporation whose shares are packaged into an ADR declares any dividend in its currency. The bank that assembled the ADR converts the dividend to US dollars and remits it to the ADR holder.

Which statements are TRUE regarding warrants?

I. Warrants generally have a life of 5 years or less
II. At issuance, the exercise price of the warrant is set higher than the current market price of the underlying common stock
III. The price of the warrant will vary with the price movements of the underlying stock
IV. The price of the warrant will vary depending upon the time to expiration of the warrant

a. I and II
b. III and IV
c. II, III and IV
d. I, II, III and IV

Answer: D

All of the statements are true about warrants. Warrants generally have a life of 5 years or less, because FINRA will not allow offerings of warrants with a longer life (5 years or more is considered to be unreasonable under FINRA rules. At issuance, the exercise price of the warrant is set higher than the current market price of the underlying common stock. Therefore, the warrant is issued at a price that is out the money and the market price of the stock must rise to at least this level for it to be worthwhile to exercise the warrant. The price of the warrant will vary with the price movements of the underlying stock. As the stock price rises, the warrant becomes more valuable; as the stock's price falls, the warrant becomes less valuable. The price of the warrant will vary depending upon the time to expiration of the warrant. The greater the time to expiration, the greater the value of the warrant since the ere is a greater probability that the price will rise in the remaining time to expiration

All of the following are methods of dividend payment EXCEPT?

a. cash
b. stock
c. rights
d. product

Answer C

The distribution of rights is not a dividend, rather it is the preemptive right of all shareholder to maintain proportionate ownership if the corporation wishes to issue additional shares. The corporation MUST distribute rights to existing shareholders if it wishes to sell new common shares. Dividend distributions, on the other hand, are voluntary payments made by the corporation to its shareholders. The amount and form of payment are determined by the Board of Directors. Dividend payments can take the form of cash; stock dividends; or product dividends.
Ex: In years past P&G would send a variety pack of its products to shareholders in addition to the regular cash dividend. In recent years, product dividends have not be popular since they are taxable to the shareholder, as is any dividend, and the owner would rather receive cash.

Preferred stock has all of the following features as compared to common stock EXCEPT:

a. fixed rate of return
b. fixed maturity
c. priority claim to dividends declared
d. priority claim to assets upon dissolution

Answer B

Preferred stock does NOT have a stated maturity - it has an indefinite life. Preferred stock does have a stated dividend rate and priority claim to both dividends and corporate assets over common stock.

A customer holds 100 shares of ABC Corp. $100 par non-convertible preferred stock. If ABC declares and pays a 10% common stock dividend, then as of the payable date, the customer will now have:

a. 90 shares of ABC preferred stock
b. 100 shares of ABC preferred stock
c. 100 shares of ABC preferred stock and 10 shares of ABC common stock
d. 110 shares of ABC preferred stock

Answer: B

Stock dividends paid to common shareholders have no impact on non-convertible preferred shareholders. This preferred shareholder has 100 shares and gets no additional shares when the common stock dividend is paid. Common stockholders have a preemptive right; preferred stockholders do not.

Preferred stock 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: C

Preferred stock is a fixed income security with an "infinite life" since there is NO maturity. The price of fixed income securities is determined by market interest rate levels. As market interest rates rise, preferred stock prices fall; as market interest rates fall, preferred stock prices rise. Since preferred stock is a long term investment, long term interest rate levels (not short term) determine market pricing.

Common stockholders and preferred stockholders BOTH have?

a. voting rights
b. preemptive rights
c. dividend rights
d. subscription rights

Answer: C

Only common stockholders have voting rights, preemptive rights and subscription rights (basically the preemptive right to subscribe to additional common shares offered by the issuer). Preferred stock does not have these rights. However, both common and preferred have the right to a cash dividend, if declared by the Board of Directors.

A company decides to split its stock 5:4. Prior to the ex-date, the stock is trading at $50 per share. The holder of 100 shares, as of the ex-date, will have:

a. 120 shares valued at $40 per share
b. 125 shares valued at $40 per share
c. 120 shares valued at $60 per share
d. 125 shares valued at $60 per share

Answer: B

A 5:4 split is a 1.25:1 stock split. Therefore for every 100 shares held, the owner will now have 1.25 x 100 = 125 shares. The market price of the stock will be adjusted to $50/1.25 = $40 per share. Note that the value of the aggregate holding ($5,000) does not change.

The definition of Treasury Stock is?

a. issued stock minus authorized stock
b. issued stock minus outstanding stock
c. authorized stock minus outstanding stock
d. outstanding stock minus authorized stock

Answer: B

Treasury stock consists of issued shares that have been repurchased by the corporation. Repurchased shares are no longer "outstanding" so the definition of Treasury Stock is issued shares MINUS outstanding shares.

Which of the following have an equity position?

I. Common Shareholders
II. Preferred Shareholders
III. Convertible Bondholders
IV. Warrant Holders

a. I and II
b. II and III
c. I, II and IV
d. I, II, III and IV

Answer: A

Owners have an equity position - and the only owners of a company are shareholders - both common and preferred. Convertible bondholders are creditors of a company. Their position only becomes equity IF they convert to common shares. Warrant holders have a long-term option to buy stock. They only become equity holders if they exercise their options.

The market price of common stock will be influenced by which of the following?

I. The par value of the shares
II. Expectations for future earnings of the company
III. Expectations for future dividends to be paid by the company
IV. Book value of the company

a. I and IV
b. II and III
c. I, II and III
d. II and IV

Answer: B

The market price of common stock is determined by investors expectations about the future of the company. Par value and book value have no bearing on the market price of the common.

Which are TRUE statements regarding the activities of the registrar?

I. The registrar cancels old shares
II. The registrar transfers shares to new owners
III. The registrar accounts for the number of shares issued
IV. The registrar keeps the shareholder record

a. I and II
b. II and IV
c. III and IV
d. I, II, III and IV

Answer: C

The transfer agent cancels old shares and issues new shares, keeping a record of current shareholder names and addresses. The registrar insures that all shares are properly accounted for and ALSO keeps a record of the shareholders' names and addresses.

Cumulative voting is considered to be an advantage to the:

a. large investors
b. institutional investors
c. small investors
d. novice investors

Answer: 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.

Which are functions of the transfer agent?

I. Mails dividend payments to the shareholders
II. Cancels old shares and issues new shares
III. Prepares and mails proxies
IV. Sets the Declaration Date

a. I and II
b. III and IV
c. I, II and III
d. I, II, III and IV

Answer: C

The declaration date is set by the Board of Directors of the company. The transfer agent cancels old shares and issues new shares, mails voting materials (proxies), annual reports and dividend payments to the shareholders.

Which of the following terms describes common stock?

a. Negotiable
b. Redeemable
c. Non-negotiable
d. Callable

Answer: A

Common stock is a negotiable (transferable) security. It is not redeemable with the issuer nor is it callable by the issuer.

The Board of Directors of a company will set all of the following EXCEPT:

a. declaration date
b. record date
c. ex-date
d. payable date

Answer: C

The ex-date is set by the exchange where the stock trades once the Board of Directors sets the Record date. The Board of Directors, when it announces a dividend, sets the Declaration date, Record date and payable date.

The regular way ex-date for cash dividends is set at:

a. 1 business day before record date
b. 2 business days before record date
c. 3 business days before record date
d. 3 business days after record date

Answer: B

The regular way ex-(reduction) date is set at 2 business days prior to the record date. If the stock is bought BEFORE this date in a regular way trade (3 business day settlement), settlement will occur on the record date or before; and the purchaser will be on the record books for the distribution.

ABC Corp. has declared a 5:4 stock split to shareholders of record on November 10th. A stockholder of record with 100 shares will receive how many additional shares?

a. 20
b. 25
c. 120
d. 125

Answer: B

A 5:4 stock split is a 5/4 = 1.25 = 25% split. The shareholder with 100 shares will get 25% more shares or 25 additional shares.

Referring to the previous question, the price of the stock will be reduced on ex-date by:

a. 20%
b. 25%
c. 30%
d. 50%

Answer: A

This is a very tricky question. Sinche the stockholder has 1.25 times the number of shares after the split, the market price will be reduced on ex date by a factor of 1.25. Assume the market price of the stock is $50 before the split. After the split, the new market price is $50/1.25 = $40. The new price is $10 less than the original $50. $10/$50 = 20% reduction from the original price.

Use the following information to answer the next 3 questions.

ABC Corp. has declared a rights offering to stockholders of record on Wednesday, December 10th. Under the offer, shareholders need 10 rights to subscribe to 1 news share at a price of $19. Fractional shares can be rounded up to purchase 1 full share.

A customer owning 111 shares wishes to subscribe. The market price of the stock is currently $30. The customer can buy:

a. 11 shares for $209
b. 12 shares for $228
c. 11 shares for $341
d. 12 shares for $372

Answer: B

The subscription offer allows fractional shares to be rounded up to buy 1 whole share. Since 10 rights are needed to buy 1 new share, the customer receiving 111 rights can buy 111/10 = 11.1 shares which rounds up to 12 shares at $19 each = $228 total for 12 shares.

As of Monday December 1st, the stock is trading at $30. The value of the right is:

a. $.90
b. $1.00
c. $1.10
d. $1.25

Answer: B

Since the record date is Wednesday, December 10th, a customer buying on Monday, December 1st would settle prior to the record date and would be on the record books for the distribution. (The trade would settle on December 4th - 3 business days after the December 1st trade date.) Therefore, the stock is trading cum rights. The value of a right "cum rights" is

Market Price - Subscription Price/N+1

$30-$19/10+1 = $11/11 = $1 Value "Cum Rights"

After the ex-date, the stock is trading at $29. The value of the right is:

a. $.90
b. $1.00
c. $1.10
d. $1.25

Answer:

Shareholder approval is need for all of the following EXCEPT:

a. declaration of a stock split
b. declaration of a stock dividend
c. declaration of a reverse stock split
d. issuance of convertible preferred stock

Answer:

Which of the following statements are TRUE regarding Treasury stock?

I. Treasury stock receives dividends
II. Treasury stock votes
III. Treasury stock reduces the number of shares outstanding
IV. Treasury stock purchases are used to increase reported Earnings per Share

a. I and II
b. III and IV
c. II, III and IV
d. I, II, III and IV

Answer:

All of the following are rights of a common shareholder EXCEPT the right to?

a. vote
b. receive a dividend
c. manage the enterprise
d. transfer share ownership

Answer: C

Common dividends are usually paid:

a. monthly
b. quarterly
c. semi-annually
d. annually

Answer: B

A customer owns 200 shares of ABC stock. ABC is having a rights offering where 20 rights are need to subscribe to 1 new share. The customer will receive:

a. 1 right
b. 10 rights
c. 100 rights
d. 200 rights

Answer:

In a corporate liquidation, common stockholders are paid:

a. before bondholders and preferred stockholders
b. after bondholders and preferred stockholders
c. after bondholders but before preferred stockholders
d. before all creditors

Answer: B

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