Series 7 unit 1 equity securities

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1.1 what is a security 1.2 stock 1.3 preferred stock 1.4 return on investment 1.5 transferbility of ownership 1.6 tracking equity securities 1.7 rights and warrants 1.8 american depository receipts 1.9 real estate investment trusts

Which of the following have equity positions in a corporation?

Common stockholders.
Preferred stockholders.
Convertible bondholders.
Mortgage bondholders.

A) I and II.
B) I and III.
C) II and IV.
D) III and IV.

Answer: A


Common and preferred stockholders have equity, or ownership positions. Bondholders (mortgage or otherwise) are creditors, not owners.

A customer owns 1,000 shares of ABC corporation. Which of the following actions on the part of ABC would dilute her equity?

A) 2-1 stock split.
B) Registered primary offering of shares.
C) Registered secondary offering of shares.
D) Payment of a 10% stock dividend.

Answer: B


An additional primary issue of shares would dilute a present shareholder's ownership, unless she personally purchases a portion of the new shares (as in a rights offering). In a secondary offering, ownership of existing outstanding shares is simply changing hands. With a stock dividend or stock split, percent equity does not change.

An informal network of market makers that offers to trade securities NOT listed on an exchange is called:

A) National Daily Quotation Service.
B) National Association of Securities Dealers Automated Quotations.
C) the over-the-counter market.
D) Archipelago Exchange (ArcaEx).

Answer: C


This best describes the over-the-counter market which is an interdealer market linked by computer terminals to Financial Industry Regulatory Authority (FINRA) member firms across the country.

Common stockholders of a publicly traded corporation have which of the following rights and privileges?

Residual claim to assets at dissolution.
Right to a vote for stock dividends to be paid.
Right to receive an audited financial report on an annual basis.
Claim against dividends in default.

A) I and IV.
B) II and III.
C) II and IV.
D) I and III.

Answer: D


Common stockholders of publicly traded companies have a residual claim to assets of a corporation at dissolution and are entitled to receive an annual report containing audited financial statements. Stockholders never get to vote on dividends.

A client has 100 shares of GHI when the stock undergoes a split. After the split, the client has:

A) a proportionately increased interest in the company.
B) greater exposure.
C) no effective change in the value of the position.
D) a proportionately decreased interest in the company.

Answer: C


When a stock splits, the number of shares each stockholder has either increases or decreases (in the case of a reverse split). The customer experiences no effective change in position because the proportionate interest in the company remains the same.

After a company splits its stock 2 for 1, an investor who owns 100 shares receives:

A) another certificate for 100 shares.
B) another certificate for 200 shares.
C) notice that the invA 2-1 split does which of the following?

After a 2 for 1 split, the transfer agent will send the investor another certificate for 100 shares. The investor is not required to return the existing stock certificate.

A 2-1 split does which of the following?

Increases the number of outstanding shares.
Decreases retained earnings.
Decreases par value per share.

A) I, II and III.
B) I and III.
C) I and II.
D) II and III.

Answer: B


After a 2-1 stock split, the number of outstanding shares doubles and the par value per share decreases by half. Retained earnings are not affected.

If a stock undergoes a 1-5 reverse split, which of the following increases?

Market price per share.
Number of shares outstanding.
Earnings per share.
Market capitalization of the company.

A) I and II.
B) II and III.
C) III and IV.
D) I and III.

Answer: D


After a reverse split, there will be fewer shares outstanding. As a result, market price and earnings per share will increase. Overall, the market capitalization of the company will not change.

ABC Inc. has 1 million shares of common stock outstanding ($10 par value), paid-in surplus of $10 million, and retained earnings of $10 million. If ABC stock is trading at $20 per share, what would be the effect of a 2-1 stock split?

A) The number of shares outstanding would decrease by 50%.
B) The market price of the stock would double.
C) The par value would decrease to $5 per share. .
D) The retained earnings would be decreased by $10 million.

Answer: C


A stock split results in more outstanding shares at a lower par value per share. The total value of stock outstanding is unchanged. Retained earnings are not affected by a stock split.

Which of the following statements regarding a 2-for-1 stock split are TRUE?

The share price is reduced by half.
The total market value of the outstanding stock decreases.
The total market value of the outstanding stock may increase or decrease as a result of the split.
The number of shares doubles.

A) II and III.
B) II and IV.
C) I and IV.
D) I and III.

Answer: C


In a 2-for-1 stock split, the number of outstanding shares is doubled and the price is reduced by half. The total market value (market cap) of the issuer's stock remains the same.

A change in earnings would affect the price of which of the following securities the most?

A) Treasury stock.
B) Common stock.
C) 10% debentures maturing in 10 years.
D) 6% preferred stock.

Answer: B


Common stock is most sensitive to earnings changes because, as owners, common shareholders have a claim on the earnings of the firm.

The residual right of common stockholders refers to their right to:

A) claim company assets in bankruptcy after wages, taxes, creditors and preferred shareholders have been paid.
B) vote in elections for the board of directors and in other important business decisions, such as changes to the charter.
C) examine the corporation's annual reports and other reports, and take legal action if irregularities are found.
D) receive all announced dividends in accordance with the number of shares held.

Answer: A


The residual right of common shareholders refers to their position in the event of bankruptcy.

If a company splits its stock 3 for 2, how many additional shares will be issued to an investor who owns 200 shares?

A) 300
B) 400
C) 500
D) 100

Answer: D


The investor will receive an additional 100 shares from a 3 for 2 stock split. To calculate the additional shares as a result of a split, multiply the existing number of shares by the split rates (200 shares × 3/2 = 300 shares). Because the investor owned 200 shares, she will be issued 100 additional shares, bringing ownership to 300 shares.

Holders of common shares may generally vote on:

A) whether an administrative assistant should be promoted to management.
B) whether the company should issue additional preferred stock.
C) whether a cash dividend is to be declared.
D) which member of the board of directors should be chairman.

Answer: B


Common shareholders must vote to approve the issuance of additional preferred stock because additional preferred shares dilutes the common shares' residual assets under a liquidation. Common shareholders do not vote to declare dividends. Board members select the chairman of the board. Shareholders do not get involved in the daily operational activity of the corporation.

Which of the following statements regarding holders of common stock are TRUE?

They must approve the payment of dividends.
They are entitled to declared dividend distributions in proportion to their ownership.
They have residual rights to corporate assets on dissolution.
They have unlimited liability.

A) II and III.
B) I and II.
C) I and IV.
D) II and IV.

Answer: A


Common stockholders are entitled to dividend distributions in proportion to their ownership and to residual rights to corporate assets on dissolution. They do not vote on the payment of dividends, and they have only limited liability.

A corporation authorized to issue 1 million shares of common stock originally issued 600,000 shares and later repurchased 40,000 shares for its treasury. How many shares of common stock will remain outstanding?

A) 560,000.
B) 40,000.
C) 600,000.
D) 960,000.

Answer: A


Stock issued minus stock reacquired equals the amount of stock outstanding. Shares repurchased are called treasury stock.

A corporation must have stockholder approval to:

A) declare a 15% stock dividend.
B) declare a cash dividend.
C) issue convertible bonds.
D) repurchase 100,000 shares of stock for its treasury.

Answer: C


Stockholders are entitled to vote on the issuance of additional securities that would dilute shareholders' equity (the shareholder's proportionate interest). Conversion of the bonds would cause more shares to be outstanding, thus reducing the proportionate interest of current stockholders. Decisions that are made by the board of directors and do not require a stockholder vote include the repurchase of stock for its treasury, declaration of a stock dividend, and declaration of a cash dividend.

ABC Corporation declares a 5-4 stock split. On the ex-date, the price of ABC common will be reduced by:

A) 0.5.
B) 0.8.
C) 0.2.
D) 0.25.

Answer: C


As a result of a stock split, an investor will have more shares at less value per share, but overall value of the investment will remain the same. For example: an investor owns 100 shares at $50 per share worth $5,000. After a 5-4 split, the investor will have 125 shares (100 × 5/4); the total ownership interest of $5,000 is divided by the new number of shares to determine the per share price of $40. The decrease of 50 to 40 is a 20% reduction. Generally, the percent decrease in price will always be less than the percent increase in the number of shares. The percent increase in shares in a 5-4 split is 25%.

Shareholder approval is required for all of the following corporate events EXCEPT:

A) the acceptance of a tender offer from a non-affiliated company.
B) the issuance of convertible bonds.
C) stock dividends.
D) stock splits.

Answer: C


Shareholder approval is not required for the payment of dividends, but is normally required for actions that increase (or potentially increase) the number of shares outstanding, such as stock splits and the issuance of convertible bonds. A corporation's acceptance of a tender offer requires shareholder approval.

In a 3-for-2 stock split, an investor will:

A) have 50% fewer shares at twice the price.
B) have two-thirds fewer shares at a 50% higher price.
C) have 50% more shares at two-thirds the price.
D) have 50% more shares at half the price.

Answer: C


If a stock splits 3 for 2, an investor will receive an additional 50 shares for every 100 shares owned. The price will decline by one-third, but the total value of the position will stay the same. For example, if a shareholder owns 100 shares before the 3 for 2 split, the shareholder will have 150 shares after the split (3 / 2 × 100 = 150).

If ABC Corp. declares a 5-4 stock split, an investor who owns 300 shares would receive how many additional shares?

A) 100.
B) 75.
C) 30.
D) 60.

Answer: B


A 5-4 split represents a 25% increase in shares. For each 4 shares owned, the investor will receive 1 new share. 1/4 = 25% increase. 300 shares × 25% = 75 shares.

When compared to statutory voting, cumulative voting gives an advantage to:

A) management rather than the board of directors.
B) minority stockholders.
C) majority stockholders.
D) participating preferred stockholders.

Answer: B


Cumulative voting allows shareholders to aggregate their votes and cast them as they please. For example, they could cast all of their votes for a single candidate. Cumulative voting makes it easier for a minority group of shareholders to gain representation on the board.

Common stockholders have all of the following rights and privileges EXCEPT:

Voting on the composition of the board of directors.
Voting on routine decisions in the company's operations.
Receiving par value at liquidation.
Receiving a dividend when declared.

A) II and IV.
B) II and III.
C) I and III.
D) I and IV.

Answer: B


Ownership of common stock allows shareholders the right to vote on the important affairs in the life of the company, not routine operational decisions. No promise is offered with regard to the stockholder's initial investment, which might be lost, or dividends, which might not be declared.

A company has reverse-split its common stock. The effect on the earnings per share will be:

A) no effect.
B) none of these..
C) an increase.
D) a decrease.

Answer: C


When a reverse split takes place, the number of outstanding shares is reduced. Since the split has no effect on earnings of the company, dividing those earnings by fewer shares will cause an increase to the earnings per share.

Minority stockholders are more likely to be able to elect directors through which form of voting?

A) Cumulative.
B) Regular.
C) Statutory.
D) Progressive.

Answer: A


Minority stockholders are more likely to be able to elect representatives to the board of directors through cumulative voting. Small stockholders may cast all of their votes on 1 position rather than spread them out and thus dilute them over 2 or 3 positions.

The common stock of ABC Corporation currently earns $3 per share. If the price-to-earnings ratio for this stock is 14, what is the current market price?

A) 37.
B) 42.
C) 17.
D) 21.

Answer: B


The price-to-earnings ratio equals the market price divided by earnings per share. The PE ratio is 14, and earnings per share is $3. Therefore, the market price is 14 × $3 = $42

The board of directors of DMF, Inc., announces a 5:4 stock split. The market price of DMF after the split should decrease in value by

A) 0.3.
B) 0.2.
C) 0.1.
D) 0.25.

Answer: B


The easy way to handle questions about stock splits is to turn the split into a fraction. You know that after a split, which increases the number of shares outstanding, the market price per share will be reduced. With a 5:4 stock split, the new price should be about 4/5 the old price. A 1/5-change equals 20% (100% / 5 = 20%).

Which of the following is TRUE concerning a 5:4 stock split?

A) The net worth of the company will be reduced.
B) Retained earnings will be increased.
C) Each shareholder's proportionate equity will be unchanged.
D) The par value will be unchanged.

Answer: C


Since each shareholder will receive additional stock, the proportional equity will remain the same.

If Flying Horse Corp. splits 5:4, the presplit $.40 par value of the common stock would now be adjusted to:

A) 0.4.
B) 0.48.
C) 0.32.
D) 0.3.

Answer: C


Stock splits will change the par value of the stock. To calculate the new value multiply the original par by the inverse of the split: 4/5 × $.40 = $.32.

Which of the following represent ownership in a corporation?

Debentures.
Convertible bonds.
Preferred stock.
Common stock.

A) III and IV.
B) I and II.
C) I and III.
D) II and IV.

Answer: A


Common and preferred stocks represent ownership in a company. Convertible debentures may be converted to equity securities, but until they are, they are considered debt.

Treasury stock is:

A) issued by the U.S. Treasury Department.
B) stock repurchased by the issuer.
C) authorized but unissued stock owned by the company.
D) preferred stock.

Answer: B


A company may, from time to time, go into the market and buy some of its own outstanding stock, which is then placed in the treasury and called treasury stock. Treasury stock has no voting rights and does not receive dividends. Treasury stock is not included when calculating shareholders' equity, or net worth.

Which of the following are TRUE of treasury stock?

Treasury stock is authorized but not yet issued.
Treasury stock may pay a reduced dividend.
Treasury stock is issued but has no voting or dividend rights.
Treasury stock is previously issued stock that has been repurchased by the issuing company.

A) I and III.
B) II and IV.
C) III and IV.
D) I and II.

Answer: C


Treasury stock is a company's stock that has been issued, sold through an offering, and then bought back by the company. When a company repurchases its own stock, that stock has no voting rights or dividend rights and is held in the issuer's treasury.

IBM's common stock is included in the S&P 100 Index. IBM declared a 5:4 stock split. What impact will this split have on the S&P Index value?

A) It will decrease.
B) Trading will be halted.
C) It will have no effect.
D) It will increase.

Answer: C


Just as the total portfolio value of an individual does not change when splits and stock dividends occur, the index will experience no real change, because the stock value used in the index is weighted by the number of shares outstanding.

A stockholder owns 200 shares of common stock in a corporation that features statutory voting. If an election is being held in which 6 candidates are running for 3 seats on the board, the stockholder could cast the votes in which of the following ways?

A) 600 votes for any 1 director.
B) 300 votes for each of 2 directors.
C) 100 votes for each of 6 directors.
D) 200 votes for each of 3 directors.

Answer: D


A stockholder has 1 vote per seat for each share of stock he owns. Thus, in this case, the stockholder has a total of 600 votes. Under the statutory voting method, he must allocate an equal number to each seat, or 200 for each of 3 seats.

Stockholders' preemptive rights include the right to:

A) purchase treasury stock.
B) sell stock back to the issuing corporation.
C) maintain proportionate ownership interest in the corporation.
D) serve as an officer on the board of directors.

Answer: C


Preemptive rights allow stockholders to maintain their proportionate ownership when the corporation wants to issue more stock. For example, if a stockholder owns 5% of the outstanding stock and the corporation wants to issue more stock, the stockholder has the right to purchase 5% of the new shares.

Which of the following securities is subject to the greatest risk?

A) XYZ Inc., common stock.
B) BAA-rated ABC convertible bond.
C) Series EE bond.
D) A-rated municipal bond.

Answer: A


Common stock is a junior security. It is considered less safe than bonds because it has the lowest claim to assets in the event of the issuing firm's liquidation, and is paid dividends after bonds are paid interest.

Which of the following securities carries the greatest amount of risk?

A) Corporate bonds.
B) Common stock.
C) Debentures.
D) Preferred stock.

Answer: B


Common stockholders are always the last to receive payment in the event of a corporate liquidation and, therefore, have the most risk. However, common stockholders have the greatest potential reward of ownership if the corporation is successful.

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

A) Convertible.
B) Cumulative.
C) Noncumulative.
D) Callable.

Answer: A


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.

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.

Answer: A


Current and unpaid past dividends on cumulative preferred stock must be paid before common stockholders can receive a dividend. Bond interest is always paid before dividends. Dividends in arrears on cumulative preferred have the highest priority of dividends to be paid.

Which of the following must be paid before a corporation may pay its cumulative preferred stock arrearages?

This year's preferred dividends.
Bond interest.
Corporate taxes.
Common stock dividends.

A) I and III.
B) I and IV.
C) II and IV.
D) II and III.

Answer: D


Before paying any dividends, the corporation must pay wages, taxes, and both interest and principal on debts that are due. Once the debt obligations have been satisfied, it may pay arrearages on cumulative preferred stock, then current fixed dividends on preferred stock, and finally common dividends.

The rate on an adjustable preferred stock may be indexed to the:

A) Consumer Price Index.
B) Producer Price Index.
C) Dow Jones Industrial Average.
D) Treasury bill rate.

Answer: D


The dividend on an adjustable rate preferred stock is tied to a particular interest rate, and the Treasury bill rate is a common benchmark.

Callable preferred stock is advantageous to the issuer because it allows the company to:

A) call in the stock at less than par value and capture the difference as income.
B) take advantage of high interest rates.
C) issue fixed-rate securities at a yield lower than usual.
D) replace a high, fixed-rate issue with a lower issue after the call date.

Answer: D


By issuing a callable preferred stock, a corporation can call in a high dividend payment issue and replace it with a lower one when interest rates decline. Callable preferred allows the company to take advantage of reduced interest rates by calling in high-rate issues and replacing them with lower ones. The marketplace requires that the company pay a higher dividend yield compared to one that is not callable. This compensates the investor for taking the risk of a future call.

Which of the following statements regarding preferred stock is NOT true?

A) Because there is no set maturity value or redemption date, the holder of preferred stock has to sell his shares in the open market to close out his position.
B) Voting rights of preferred shareholders take precedence over those of common shareholders.
C) Unlike debt, preferred stock has no set maturity date.
D) The dividend is fixed except in the case of adjustable preferred.

Answer: B


Preferred shareholders do not generally have voting rights. Voting rights are characteristic of common stock, not preferred. Preferred stock is unlike debt securities in that it has no set maturity date. It is true that the dividend on a preferred stock is fixed, except in the case of an adjustable preferred where the dividend can be tied to a market interest rate and readjusted. The holder of a preferred has to sell the shares in the open market to close out his position.

ABC Corporation has a 10% noncumulative preferred stock outstanding at $100 par value. Two years ago, ABC omitted its preferred dividend, and last year, it paid a dividend of $5 per share. To pay a dividend to common shareholders, each preferred share must be paid a dividend of:

A) 25.
B) 10.
C) 5.
D) 15.

Answer: B


Because this is noncumulative preferred stock, the company must pay only this year's full stated dividend of $10 per share before paying dividends to the common shares.

As interest rates fall, prices of straight preferred stock will:

A) rise.
B) fall.
C) remain unaffected.
D) become volatile.

Answer: A


Preferred stock is interest rate sensitive. As rates fall, prices of preferred stocks tend to rise, and vice versa.

In a portfolio containing common stock, preferred stock, convertible preferred stock, and ADRs, changes in interest rates would most likely affect the market price of the:

A) preferred stock.
B) common stock.
C) convertible preferred stock.
D) ADRs.

Answer: A


Preferred stock has the closest characteristics to bonds and would be most affected by a change in interest rates. Convertible preferred stock would also be affected by price changes in the underlying common stock.

A customer owns cumulative preferred stock (par value of $100) that pays an 8% dividend. The dividend has not been paid this year or for the 2 previous years. How much must the company pay the customer per share before it may pay dividends to the common stockholders?

A) 24.
B) 0.
C) 8.
D) 16.

Answer: A


If the company is going to pay a common stock dividend, it must pay the preferred dividends first. A cumulative preferred stockholder must also receive all dividends in arrears. There are $16 due in back dividends in addition to $8 this year, for a total of $24.

Which of the following securities typically carries the highest dividend rate?

A) Callable preferred.
B) Straight preferred.
C) Convertible preferred.
D) Participating preferred.

Answer: A


Straight preferred is the benchmark rate. As the name suggests, there are no conversion or participating features. Compared to straight preferred, both convertible and participating preferred tend to carry lower dividend rates, as the investor has been given something extra-the right to convert into common shares at a fixed price or the right to earn more than the stated rate if the issuer has a good year and the board of directors elects to make an additional dividend payment. Callable preferred allows the issuer to call the securities away from the investor. From an investor's point of view, this is not an incentive. Therefore, callable preferred tends to pay higher rates.

A convertible preferred stock issue (par value $100) is selling at $125 and is convertible into 5 shares of common stock. The conversion price of the common stock is:

A) 25.
B) 100.
C) 1200.
D) 20.

Answer: D


Par value divided by conversion price equals the number of shares into which the security is convertible. If this security is convertible into 5 shares, we need to know what number goes into $100 5 times. That number is $20. The current market value of the preferred stock is unnecessary information.

In general, a corporation assumes the least risk when it obtains funds from:

A) sale of preferred stock.
B) a commercial bank.
C) sale of debentures.
D) sale of income bonds.

Answer: A


Unlike the other choices, the sale of preferred stock does not entail the assumption of debt and is therefore the least risky. It is always riskier to borrow than it is to raise equity because equity does not have to be paid back.

A similarity between common and preferred stock is:

A) the dividend must be declared by the board of directors.
B) the dividend is fixed.
C) they have an equal vote.
D) both are evidence of corporate indebtedness.

Answer: A


All dividends, both common and preferred, must be declared by the board of directors. Preferred shares usually have a fixed dividend rate and usually have no (or very limited) voting powers. Both types of stock are equity, not debt, securities.

If all other factors are equal, an investor would expect which type of preferred stock to pay the highest stated dividend rate?

A) Convertible.
B) Callable.
C) Straight.
D) Cumulative.

Answer: B


When the stock is called, dividend payments are no longer made. With callable preferred stock, to compensate for that possibility, 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.

Cement Mixer Corporation has 1 million shares of convertible preferred stock and 2 million shares of common outstanding. Each share of preferred can be converted into ½ share of common. The preferred stock is selling at $17.50 and the common stock is selling at $35.75. If all preferred shares were converted, how many shares of common stock would be outstanding after conversion?

A) 2 million.
B) 3 million.
C) 2.5 million.
D) 500000.

Answer: C


One million shares of preferred, each converted to ½ share of common, is 500,000 common shares. Five hundred thousand shares after conversion added to 2 million shares of common previously outstanding equals 2.5 million common shares.

A customer purchases an ABC 6-½% convertible preferred stock at $80. The conversion price is $20. If the common stock is trading 2 points below parity, the price of ABC common is:

A) $12.
B) $16.
C) $18.
D) $14.

Answer: D


The conversion ratio is computed by dividing par value by the conversion price ($100 par / $20 = 5). Parity price of the common stock is computed by dividing the market price of the convertible by the conversion ratio ($80 / 5 = $16). $16 − 2 = $14.

Your customer owns 100 shares of DWQ trading at $50 per share. He hears that DWQ has declared a 25% stock dividend and wants to know how that will affect his holdings after the stock dividend is paid. You should advise the customer that based on the current price he will own:

A) 125 shares at $40.
B) 100 shares at $40.
C) 100 shares at $50.
D) 125 shares at $50.

Answer: D


The number of shares increased by 25%, or 25 shares. Total market value remains the same. To calculate the new market price, divide $5,000 (total market value) by 125 to get the after-dividend price of $40 per share.

A company may pay dividends in which of the following forms?

Preemptive rights.
Cash.
Its own stock.
Its own bonds.

A) I and III.
B) I and IV.
C) II and IV.
D) II and III.

Answer: D


A company may pay a dividend in stock of another company, cash, its own stock, or its own product. Preemptive rights are used in subsequent primary offerings, and bonds trade separately.

ABC's stock has paid a regular dividend every quarter for the last several years. If the price of the stock has remained the same over the past year, but the dividend amount per share has increased, it may be concluded that ABC's:

A) current yield per share has decreased.
B) current yield per share has been unaffected.
C) yield to maturity has gone up.
D) current yield per share has increased.

Answer: D


The current yield would have increased because current yield is the income (dividend) divided by price. A higher dividend divided by the same price results in a higher yield. Stocks do not have a yield to maturity.

A company's dividend on its common stock is:

A) determined by its board of directors.
B) voted on by shareholders.
C) mandatory if the company is profitable.
D) specified in the company charter.

Answer: A


A common stock's dividend payment and amount are determined by the company's board of directors.

Your client owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date, what will he own?

125 shares.
100 shares.
Cost of $25.
Cost of $20.

A) II and III.
B) II and IV.
C) I and IV.
D) I and II.

Answer: C


Stock dividends make the number of shares owned increase and the cost per share decrease. The overall value should remain unchanged before and after the adjustment: 125 shares × $20 = $2,500, and 100 shares × $25 = $2,500

GHI currently has earnings of $4 and pays a $.50 quarterly dividend. If GHI's market price is $40, the current yield is:

A) 5%.
B) 1.25%.
C) 10%.
D) 15%.

Answer: A


The quarterly dividend is $.50, so the annual dividend is $2; $2 /· $40 market price = 5% current yield.

A company with 20 million shares outstanding paid $36 million in dividends. If the current market value of the company's shares is $36, the current yield is:

A) 5%.
B) 2%.
C) 10%.
D) not determinable from the information given.

Answer: A


The current yield formula is annual dividends per share divided by current market price. The dividends per share are $36 million /· 20 million shares = $1.80 per share. Current yield is $1.80 / $36.00 = 5%.

GHI stock is at $10 par value and is selling in the market for $60 per share. If the current quarterly dividend is $1, the current yield is:

A) 1.7%.
B) 10%.
C) 6.7%.
D) 1%.

Answer: C


Current yield is determined by dividing the annual dividend of $4 ($1 per quarter × 4 = $4) by the current stock price of $60 ($4 / $60 = 6.7%).

If a common stock is currently selling for $75 per share with a quarterly dividend of $.75, the current yield for the stock is:

A) 1%.
B) 3%.
C) 10%.
D) 4%.

Answer: D


The current yield formula is annual dividend divided by current price. In this case, $3 ($.75 × 4) / $75 = 4%.

A company has paid a dividend every quarter for the past 20 years. If the stock's price has fallen dramatically over the past quarter, but the dividend has remained the same, it may be concluded that:

A) current dividend yield has remained the same.
B) dividend yield to maturity has decreased.
C) current dividend yield has increased.
D) current dividend yield has decreased.

Answer: C


Current dividend yield is income dividend divided by price. If the price of a stock decreases and the dividend remains the same, dividend yield will increase

A company currently has earnings of $4 and pays a $.50 quarterly dividend. If the market price is $40, what is the current yield?

A) 15%.
B) 5%.
C) 1%.
D) 10%.

Answer: B


The quarterly dividend is $.50, so the annual dividend is $2.00; $2 / $40 (market price) = 5% annual yield (current yield).

A customer purchases stock for $40 per share, holds it for 10 months, and then sells it for $50 per share. If the customer's tax bracket is 30%, what is the after-tax rate of return?

A) 12.5%.
B) 24%.
C) 17.5%.
D) 10%.

Answer: C


The customer's return on the stock is the $10-per-share short-term capital gain ($50 − $40). The after-tax rate of return is found by computing the after-tax earnings ($10 [100% - 30%] or $10 [.70] = $7) and dividing this amount by the amount originally invested ($7 / $40 = .175 or 17.5%). Short-term gains are taxed at the same rate as ordinary income.

If GHI currently has earnings of $3 and pays an annual dividend of $1.75 and GHI's market price is $35, the current yield is

A) 5%.
B) 1.75%.
C) 3%.
D) 8.6%.

Answer: A


The current yield is calculated by dividing the annual dividend by the current market value ($1.75 / $35 = 5%).

Which of the following statements regarding the effects of a stock dividend is TRUE?

A) The market value of the stock is decreased.
B) Capital surplus is reduced.
C) New capital is channeled to the company.
D) Net current assets are decreased.

Answer: A


A stock dividend results in an increased number of outstanding shares, each with a lower value per share. The total value of stock outstanding is unchanged. There is no new capital generated from a stock dividend. Current assets are unchanged because there is no increase or decrease to the company's cash as a result of the stock dividend.

Which of the following statements regarding the Committee on Uniform Securities Identification Procedures (CU.S.IP) number is CORRECT?

A) It ensures that the security is negotiable.
B) It is used in place of the registered owner's signature.
C) It facilitates tracking and identification of a security.
D) It is evidence of ownership in a corporation.

Answer: C


The CU.S.IP assigns a unique number to each class of common and preferred stock and to each issue of corporate and municipal bond; this number is used to identify and track a particular security. The stock certificate itself, not the CU.S.IP number, is evidence of ownership in the issuing company. The presence of a CU.S.IP number does not make a security negotiable.

Which of the following is a function of a registrar?

A) Canceling old shares.
B) Transferring shares into the name of a new owner.
C) Accounting for the number of shares outstanding.
D) Recording the names of stockholders on the corporation's books.

Answer: C


The registrar's function is to ensure that the number of shares outstanding does not exceed the number accounted for on the corporation's books. The transfer agent records the names of stockholders on the corporation's books, cancels old shares, and transfers shares into a new owner's name.

Which of the following activities are NOT a registrar's function(s)?

Audit the transfer agent.
Accounting for the number of shares outstanding.
Canceling old shares.
Transferring shares into the new owners' names.

A) I and II.
B) I and IV.
C) II and III.
D) III and IV.

Answer: D


The registrar accounts for the number of shares and audits the transfer agent.

Who is responsible for ensuring that a corporation does not have more shares of stock outstanding than it has been authorized to issue?

A) FINRA.
B) Transfer agent.
C) SEC.
D) Registrar.

Answer: D


The registrar is responsible for keeping careful account of the number of shares a company is authorized to issue and ensuring that the number outstanding does not exceed this number.

For reporting purposes, an order to sell 25 shares of an OTC equity security priced at $230 per share is:

A) 25 round lots.
B) 1 round lot.
C) 1 odd lot.
D) 25 odd lots.

Answer: A


For OTC equity securities trading at or above $175 per share, 1 share is considered to be a round lot unit of trading. Therefore all last sale information will be disseminated for any transaction of one share or more.

When disseminating information about transactions of OTC equity securities, 1 share equals 1 round lot for stocks trading at or above:

A) $175 per share.
B) $125 per share.
C) $150 per share.
D) $200 per share.

Answer: A


In instances where OTC stocks are trading at or above $175 per share, 1 share equals 1 round lot. In all other cases, similar to listed equity securities, 100 shares equals 1 round lot for OTC equity securities.

The regular way ex-dividend date for cash dividends is the:

A) 2nd business day preceding the settlement date .
B) 3rd business day preceding the record date.
C) 2nd business day preceding the record date.
D) 2nd business day following the record date.

Answer: C


The regular way ex-dividend date is 2 business days before the record date.

The board of directors is responsible for setting all of the following EXCEPT:

A) ex-dividend date.
B) declaration date.
C) payable date.
D) record date.

Answer: A


The ex-date for a distribution is set by the appropriate self-regulatory organization. The issuer determines the other dates listed.

If a stock's ex-dividend date is Tuesday, January 13, when is the record date?

A) Tuesday, January 20.
B) Thursday, January 15.
C) Wednesday, January 7.
D) Thursday, January 8.

Answer: B


The record date is two business days after the ex-dividend date (Thursday, January 15).

If a stock is sold on November 30 when the record date for a dividend distribution is December 1, the seller is:

entitled to the dividend if the trade is done regular way.
not entitled to the dividend if the trade is done regular way.
entitled to the dividend if the trade is done with cash settlement.
not entitled to the dividend if the trade is done with cash settlement.

A) II and III.
B) II and IV.
C) I and IV.
D) I and III.

Answer: C


Anyone who owns the stock on the record date will receive the dividend. In a regular way trade, the seller will still be owner of record on record date, as the trade will settle after the record date. In a cash settlement transaction, the buyer will be owner of record on record date.

ABC Corporation has declared a record date of Thursday, May 17, for its next quarterly cash dividend. When is the last day the investor may purchase the stock regular way and receive the dividend?

A) Tuesday, May 15.
B) Wednesday, May 16.
C) Thursday, May 17.
D) Monday, May 14.

Answer: D


In order to receive a cash dividend, an investor must be owner of record as of the close of business on record date. Because regular way settlement is 3 business days, the customer must purchase the stock no later than Monday, May 14.

The ex-dividend date is the:

date on and after which the buyer is entitled to the dividend.
date on and after which the seller is entitled to the dividend.
second business day before the record date.
second business day after the record date.

A) I and II.
B) I and IV.
C) II and IV.
D) II and III.

Answer: D


Stock sold on the ex-dividend date entitles the seller to the dividend; ex-date is two business days before the record date.

The record date:

A) is fixed by the SEC to determine which investors own stock.
B) indicates when the public offering of new issues can be made legally.
C) is set by the issuing corporation as the mailing date for distribution of cash dividends.
D) is set by the issuing corporation to determine which stockholders will receive a declared dividend.

Answer: D


The record date is set by the corporation, at which time a list of stockholders who will receive a dividend is compiled.

While looking at a stock listing in the financial section of your local newspaper, you notice that the dividend is indicated by the notation ".15q." If you owned 1,000 shares, you could anticipate annual dividends of:

A) 15.
B) 60.
C) 150.
D) 600.

Answer: D


The notation .15q indicates a quarterly dividend of $.15. Therefore, the annual dividend is $.60 per share. 1,000 shares × .60 = the annual dividend of $600.

The last day that stocks can be bought for cash and still receive the dividend is:

A) on the ex-date.
B) the day after the record date.
C) the business day prior to the regular way ex-date.
D) the record date.

Answer: D


A cash trade settles the same day. Stocks bought for cash on the record date will be entitled to the dividend under an exception to the 2-business day rule for regular way transactions.

The ex-date for NYSE-listed issues is set by:

A) the issuer.
B) the SEC.
C) the NYSE.
D) FINRA.

Answer: C


The ex-date is set by the market where the security principally trades.

The following chart shows the capital transactions of ABC Corporation. Date Event Amount
10-19-96 Initial Offerings 6 million shares
4-1-2000 Treasury Purchase 500,000 shares


ABC wants to raise additional capital by selling 2 million shares through a rights offering and engages an underwriter on a standby basis. By the expiration date, ABC was only able to sell 1 million shares to existing shareholders. After expiration, how many shares does ABC have outstanding?

A) 8 million.
B) 7.5 million.
C) 6.5 million.
D) 7 million.

Answer: B


Before the rights offering, the company had 5.5 million shares outstanding (6 million issued minus 500,000 Treasury shares). In connection with the offering, ABC engages a standby underwriter that commits to purchase any unsold shares. Therefore, regardless of the number of shares initially subscribed to, all 2 million shares will be sold.

If a corporation attaches warrants to a new issue of debt securities, which of the following would be a resulting benefit to the corporation?

A) Reduction of the number of shares outstanding.
B) Increase in earnings per share.
C) Reduction of the debt securities' interest rate.
D) Dilution of shareholders' equity

Answer: C


Usually, a warrant is issued along with a debt instrument, an enhancement that allows the issuer to offer a slightly lower rate of interest.

Which of the following securities CANNOT pay a dividend?

A) Class B common stock.
B) Warrant.
C) ADR.
D) Convertible preferred stock.

Answer: B


Warrants represent long-term options to buy stock at a fixed price, and, like options, cannot pay dividends.

ABC, Inc. will issue new stock through a rights offering. Terms of the offering are 10 rights plus $10 to purchase one new share of stock, with any fractional shares to be considered whole shares. ABC is currently trading at $13. If your customer owns 85 shares of ABC and wishes to subscribe to the new offering, how many shares can she purchase at the subscription price and how much money will be required?

A) 8 shares; $80.
B) 8 shares; $90.
C) 9 shares; $80.
D) 9 shares; $90.

Answer: D


Your customer is entitled to 90 rights with her current holding of 85 shares (fractional shares are rounded up). Because each share requires 10 rights and $10, the customer can buy 9 shares and must pay $90.

A new bond issue will include warrants to:

A) increase the spread to the underwriter.
B) compensate the underwriter for handling the issue.
C) increase the price of the issue to the public.
D) increase the attractiveness of the issue to the public

Answer: D


By including warrants with debt issues, issuers increase the marketability of bonds. The warrants offer a long-term opportunity to buy the underlying stock at a fixed price. In addition to increasing the marketability of the issue, the issuer can offer the bonds with a lower coupon rate and, as a result, reduce fixed costs.

All of the following statements describe stock rights EXCEPT:

A) they are most commonly offered with debentures to make the offering more attractive.
B) they are short-term instruments that become worthless after the expiration date.
C) they are issued by a corporation.
D) they are traded in the secondary market.

Answer: A


A corporation issues rights to existing shareholders to allow them to purchase enough stock, within a short period and at less than current market price, to maintain their proportionate interest in the company. Rights need not be exercised but may be traded in the secondary market. Warrants, not rights, are often issued with debentures to sweeten the offering.

All of the following statements describe warrants EXCEPT:

A) short-term instruments that become worthless after the expiration date.
B) most commonly offered in connection with debentures to sweeten the offering.
C) issued by a corporation.
D) traded in the secondary market.

Answer: A


Warrants are commonly used to make debenture offerings more attractive and have long lives (generally 2 to 10 years). Warrants need not be exercised, but may be traded in the secondary market.

Which of the following statements regarding warrants is TRUE?

A) Warrants are safer than corporate bonds.
B) Warrants are often issued with other securities to make the offering more attractive.
C) Warrants give the holder a perpetual interest in the issuer's stock.
D) Warrants' terms are generally shorter than rights' terms

Answer: B


Warrants are generally issued with bond offerings to make the bonds more attractive. Warrants are long-term options to buy stock, and because they are equity securities, warrants, as investments, are considered less safe than bonds.

ABC Corporation, whose common stock is trading at $32, has issued $40 million of 8-1/8% debentures due 10-1-14. Each bond issued has a warrant attached enabling the holder to buy 4 shares of ABC common at $40 per share. If all of the warrants are exercised, ABC Corporation will receive:

A) $10 million.
B) $12.8 million.
C) $20 million.
D) $6.4 million.

Answer: D


There are a total of 40,000 warrants outstanding ($40 million of debentures / $1,000 par value per bond). Each warrant entitles the holder to buy 4 shares of common stock. Therefore, if all warrants are exercised, holders will be purchasing 160,000 shares (4 × 40,000) at $40 per share. 160,000 × $40 = $6.4 million.

Which of the following statements regarding warrants are TRUE?

They pay dividends.
They are attractive to speculators because of the leverage.
They allow for the purchase of common stock at a fixed price.
They are equity-equivalent securities.

A) III and IV.
B) II, III and IV.
C) I and III.
D) I and IV.

Answer: B


Holders of warrants have the right to buy stock from the issuer at a stated price for a specific time period. Warrants are attractive to speculators because the subscription price is higher than the current market price at issuance; therefore, the warrants' purchase price is low, as they are out-of-the-money. Dividends are only paid to stockholders.

Smith and Co., Inc. has 1 million shares of common stock outstanding and plans to sell 200,000 new shares via a rights offering. Joe Wilson, a common stockholder, owns 200 shares of the company. How many rights will he receive in the mail, and how many rights will it take to purchase one of the new shares?

A) 200 rights, 5 per share.
B) 100 rights, 5 per share.
C) 100 rights, 20 per share.
D) 200 rights, 20 per share.

Answer: A


Stockholders receive one right per share owned. Hence, Joe receives 200 rights. The purpose is to maintain shareholders' proportionate interest in the company. Since the number of shares outstanding will increase by 20%, Joe needs to purchase 40 new shares (200 / 40 = 5 rights per share).

ABC, a publicly held Corporation, decides to issue shares in an additional public offering. If the APO is for an additional 1 million shares and 60% of the shares are subscribed to in the preemptive rights offering, how many shares will the standby underwriter for this offering have available to sell to the public?

A) 110,000.
B) 600,000.
C) 400,000.
D) 100,000.

Answer: C


If 60% of the additional shares are subscribed to by existing shareholders, then 40% of the additional shares will be available to be sold to the public through a standby (firm commitment) underwriting (1,000,000 × 40% = 400,000).

A subscription right or privilege is best defined as:

A) the right of shareholders to purchase company shares at a specific price within the next 5 years.
B) the right of current shareholders to maintain their fractional ownership of a company by buying a proportional number of shares of any future issue of common stock.
C) the right of shareholders to buy any future issue of the company's preferred stock prior to submitted public orders.
D) the right of shareholders to maintain their percentage ownership of a company by selling a proportional number of warrants.

Answer: B


Current shareholders may maintain their percentage of ownership of a company by buying a proportional number of shares of any future issue of common stock. Purchasing shares prior to public orders is also known as a "preemptive right" and is often available only if made explicit in a company's corporate charter.

A company is offering investors the opportunity to purchase shares for the next 5 years at a fixed price slightly above today's market price. The company is issuing:

A) warrants.
B) futures.
C) a letter of intent.
D) call options.

Answer: A


A warrant is a security that allows the holder to purchase shares of the underlying issue at a fixed price (above the current market price when issued) for an extended period (typically 2 years or longer). Call options are similar, except they are short-term securities (9 months at issue).

Gargantuan Computers, Inc. (GCI) is proposing an additional public offering of common stock. It conducts a rights offering to its current shareholders at $55 per share, plus 5 rights. If the current market price of GCI is $70, what is the value of one right before the stock trades ex-rights?

A) 5.
B) 15.
C) 2.5.
D) 3.

Answer: C


The stock is trading cum rights, which means that 5 rights plus 1 are used to value the rights. The difference between the market price and the subscription price is $15 ($15 / 6 = $2.50).

Gargantuan Computers, Inc. (GCI) is proposing an additional public offering of common stock. It conducts a rights offering to its current shareholders at $55 per share, plus 5 rights. If the current market price of GCI is $70, what is the value of one right before the stock trades ex-rights?

A) 15.
B) 2.5.
C) 3.
D) 5.

Answer: B


The stock is trading cum rights, which means that 5 rights plus 1 are used to value the rights. The difference between the market price and the subscription price is $15 ($15 / 6 = $2.50).

GC, Inc., is proposing an additional public offering of common stock. It conducts a rights offering to its current shareholders at $55 per share, plus 5 rights. If the market price of GCI is $70 after the ex-rights date passes, what is the value of 1 right?

A) 15.
B) 3.
C) 2.5.
D) 5.

Answer: B


Since the stock is selling ex (after ex-rights), the formula is ($70 − $55) / 5. ($70 − $55 = $15) ($15 / 5 = $3).

New Offering: 800,000 units at $6 per unit. Each unit has 2 shares of common stock and 1 warrant. Each warrant is to purchase ½ share of common stock. Based on the information above, how many shares of stock will be sold, and how many warrants will be sold?

A) 1.6 million shares and 400,000 warrants.
B) 800,000 shares and 400,000 warrants.
C) 800,000 shares and 200,000 warrants.
D) 1.6 million shares and 800,000 warrants.

Answer: D


Warrants may be distributed to stockholders in an underwriting as part of a unit. The warrant is a form of bonus to entice investors to purchase the unit. As each unit contains 2 shares, 1.6 million shares are being distributed. As each unit also includes 1 warrant, 800,000 warrants are being distributed.

A tombstone for a new bond issue announces that 5-year warrants to purchase shares of the company's common stock at $75 are attached to the bonds. The current market value of the company's stock is $45. For what reason were the warrants attached to the bonds by the issuer?

A) To decrease the dilution of the current shareholders.
B) To make the bonds convertible into the issuer's common stock.
C) To improve the marketability of the bond issue.
D) To increase the dilution of the current shareholders.

Answer: C


Warrants are often issued as a bonus (or sweetener) to entice investors to purchase new bond issues. Dilution may occur at the time the warrants are exercised (if ever), but this would not be a reason for their issuance. A warrant has nothing to do with the bond's convertibility into the underlying common stock.

All of the following are characteristics of a rights offering EXCEPT:

A) the subscription price is below the CMV.
B) it is issued to current stockholders.
C) the rights are marketable.
D) the subscription period is up to 2 years.

Answer: D


Rights offerings are usually very short-lived (30 to 45 days).

A member of the investment banking department of ABC securities is explaining some of the advantages and disadvantages of rights and warrants to the board of directors of XYZ Corporation. Which of the following statements could he make?

The exercise prices of stock rights are usually below CMV of the underlying security at time of issue.
The exercise prices of warrants are usually above CMV of the underlying security at time of issue.
Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value.
Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer.

A) I, II and III.
B) I, II, III and IV.
C) I only.
D) I and II.

Answer: B


All are true statements. The exercise prices of stock rights are usually below CMV of the underlying security at time of issue. The exercise prices of warrants are usually above CMV of the underlying security at time of issue. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer.

Which of the following statements about warrants is NOT true?

A) Warrants may be attached to another of the issuer's securities.
B) Warrants have an exercise price above the current market price of the common stock when issued.
C) Warrants may not be traded in the secondary market.
D) Warrants have longer lifetimes than rights.

Answer: C


Warrants usually have lifetimes of 2-10 years; rights expire in 30-45 days. A corporation may attach warrants to other securities, such as bonds, to make the bonds more marketable. Warrants have no intrinsic value when issued and may expire without ever having intrinsic value. Before expiration, they may be, and often are, traded in the secondary market.

Mr. Brown has several stock rights. Which of the following is NOT an alternative regarding these stock rights?

A) Exercising.
B) Redeeming them from the issuer for cash.
C) Giving the rights to his son.
D) Selling at the market.

Answer: B


Rights are not redeemable by the issuer. They may be sold in the secondary market or be given to someone else to exercise. If exercised, rights are exchanged for an appropriate number of shares of the underlying common stock.

Dividends may be paid to holders of:

A) treasury stock.
B) American depositary receipts.
C) rights.
D) warrants.

Answer: B


American depositary receipts (ADRs) are vehicles that facilitate the trading of foreign securities. Rights and warrants allow holders to purchase stock from a corporation. Treasury stock has been issued, bought back, and is not entitled to dividends.

An ADR represents a:

A) U.S. security trading in a foreign market.
B) U.S. security trading in both the U.S. and a foreign market.
C) foreign security trading in both the U.S. and a foreign market.
D) foreign security trading in the U.S. market.

Answer: D


ADRs are receipts issued by U.S. banks that represent ownership of a foreign security and are traded in U.S. securities markets.

ADR owners have all the following rights EXCEPT:

A) the right to receive the underlying foreign security.
B) the right to sell the ADR in the foreign market.
C) the right to sell in the secondary market.
D) the right to receive dividends in U.S. dollars.

Answer: B


The purpose of the ADR is to facilitate trading in U.S. markets. The ADR can only be traded here. If the owner exercises the right to obtain the actual foreign security, it may be sold overseas

Answer: B


The purpose of the ADR is to facilitate trading in U.S. markets. The ADR can only be traded here. If the owner exercises the right to obtain the actual foreign security, it may be sold overseas

Answer: D


ADRs carry currency risk because distributions on ADRs must be converted from foreign currency to U.S. dollars on the date of distribution. In addition, the trading price of the ADR is affected by foreign currency fluctuation.

Which of the following statements regarding ADRs are TRUE?

They are issued by large domestic commercial banks.
They are issued by foreign banks.
They facilitate U.S. trading in foreign securities.
They facilitate a foreign investor who wants to trade U.S. securities.

A) II and IV.
B) I and III.
C) I and IV.
D) II and III.

Answer: B


ADRs are issued by large domestic commercial banks to facilitate U.S. investors who want to trade in foreign securities.

ADRs are used to facilitate the:

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.

Answer: D


An ADR is a negotiable security that represents an ownership interest in a non-U.S. company. Because they trade in the U.S. marketplace, ADRs allow investors convenient access to foreign securities.

Which of the following statements regarding ADRs are TRUE?

Dividends are payable in the underlying foreign currency.
Dividends are payable in U.S. dollars.
Holders have voting rights.
Holders do not have voting rights.

A) I and III.
B) I and IV.
C) II and III.
D) II and IV.

Answer: D


The holder of an ADR does not hold the shares of the underlying security but instead holds a receipt for those shares and therefore does not have voting rights. ADRs are U.S. securities traded in U.S. markets in U.S. dollars, with dividends payable in U.S. dollars as well.

Which of the following taxes does NOT impact the holder of an ADR?

A) State income tax.
B) Foreign income tax.
C) Excise tax.
D) Federal income tax.

Answer: C


Dividends on ADRs are subject to both federal and state income tax. In addition, the country of origin will frequently levy a tax which may be used as a credit on the investor's federal income tax return.

The issuer of an ADR is a:

A) foreign branch of a domestic bank.
B) domestic branch of a domestic bank.
C) domestic branch of a foreign bank.
D) foreign branch of a foreign bank.

Answer: A


The American Depositary Receipt (ADR) is issued by a foreign branch of a domestic bank. Everything is in English and in U.S. dollars.

A holder of an ADR assumes all of the following risks EXCEPT:

A) foreign currency risk.
B) market risk.
C) political risk.
D) liquidity risk.

Answer: D


An American Depository Share (ADR) represents an ownership interest in a foreign domiciled company. The shares trade on the New York Stock Exchange or in the OTC. The risk of lack of liquidity is absorbed by the presence of trading on U.S. exchanges or in the OTC market. The shares are subject to market risk, political risk, and foreign currency risk.

Which of the following is an advantage of owning American depositary receipts?

A) The investor avoids the currency risk that characterizes many foreign investments.
B) The investor can buy, sell, and receive dividends in U.S. dollars rather than a foreign currency.
C) The investor has the right to vote at stockholders' meetings.
D) The investor receives preemptive rights should the issuer make an additional stock offering.

Answer: B


ADRs permit an American investor to purchase, not stock, but a certificate of deposit for stock in a foreign company. The advantage is that the transactions are done in dollars, but the ADR itself does not carry a vote or stock rights, and subjects the owner to currency risk.

Investors should always be aware of taxes applicable to investments they own. Which of the following taxes might be associated with income derived from ADRs but not income from other investments?

A) Foreign income tax.
B) Federal income tax.
C) State income tax.
D) Excise tax.

Answer: A


In most countries, a withholding tax on dividends is taken at the source. To the holder of an ADR, this would be a foreign income tax. The foreign income tax paid may be taken as a credit against U.S. income taxes owed.

An ADR is used to:

A) finance foreign trade in which U.S. citizens are engaged.
B) sweeten a bond offering.
C) facilitate trading foreign securities in U.S. markets by U.S. citizens living in the United States.
D) facilitate trading U.S. securities in foreign markets by U.S. citizens living abroad.

Answer: C


American depositary receipts (ADRs) make trading in foreign securities easier in U.S. markets for U.S. investors.

For U.S. investors holding American Depositary Receipts (ADRs), dividends received are:

A) subject to a foreign withholding tax.
B) tax-free in the country of origin.
C) tax-free in both the country of origin and in the U.S.
D) taxed as a capital gain in the U.S.

Answer: A


Any tax taken on dividends received from ADRs is taken in the country of origin. This is a foreign withholding tax for U.S. investors. The foreign withholding tax may later be taken as a credit against any U.S. income taxes owed by the U.S. investor.

Which of the following are characteristics of a REIT?

It is traded on an exchange or over the counter.
It is professionally managed.
It passes through both gains and losses to investors.
It is a type of limited partnership.

A) II and III.
B) III and IV.
C) I and II.
D) I and IV.

Answer: C


A REIT shares some features with a limited partnership, but it is a different type of business entity. REITs are traded on exchanges and OTC and are professionally managed. Both REITs and limited partnerships provide pass-through of gains to investors, but REITs do not provide pass-through of losses.

If a customer holds certificates of beneficial interest in a REIT, each of the following statements regarding this investment is true EXCEPT:

A) investors receive dividends periodically.
B) the certificates are publicly traded.
C) the issuer must redeem certificates on shareholder request.
D) a mortgage REIT represents pooled capital for real estate financing.

Answer: C


REITs are not redeemed by the issuer. REITS are publicly traded units that represent either an interest in pooled capital for real estate financing or an interest in real property and that pass through income and capital gains distributions to investors. Investors who wish to liquidate their interests must sell them in the secondary market.

All of the following characteristics are advantages of a REIT EXCEPT:

A) professional management.
B) tax deferral.
C) liquidity.
D) diversification.

Answer: B


A REIT is a professionally managed company that invests in a diversified portfolio of real estate holdings. REITs are traded on exchanges and OTC, which provides liquidity. The IRS does not permit tax deferrals on REIT investments.

If a client who seeks diversification through real estate is concerned about illiquidity associated with investing in real estate, which of the following investments is most suitable?

A) Privately placed investment.
B) Real estate investment trust.
C) Interest in a real estate limited partnership.
D) Direct investment in a shopping center renting retail space to a broad variety of stores.

Answer: B


Real estate investment trusts (REITs) are best suited to the client because they are market-traded securities that provide an investor with a liquid market in which to invest in real estate

All of the following are true of REITs EXCEPT:

A) they must invest at least 75% of their assets in real estate-related activities.
B) they must to qualify under Subchapter M, distribute at least 90% of their net investment income.
C) they must be organized as trusts.
D) they must pass along losses to shareholders.

Answer: D


REITs engage in real estate activities and can qualify for favorable tax treatment if they pass through at least 90% of their net investment income to their shareholders. While they can pass through income, they cannot pass through any losses; they are not DPPs.

REITs can distribute all of the following to their shareholders EXCEPT:

A) capital losses.
B) capital gains.
C) cash dividends.
D) stock dividends.

Answer: A


REITs can distribute their income to shareholders but not their losses. Under subchapter M of the Internal Revenue Code, they must distribute at least 90% of their income to shareholders in the form of cash dividends.

Cash dividends from REITs are:

A) not taxed.
B) taxed as ordinary income.
C) taxed at a maximum rate of 15%.
D) taxed as long-term capital gains.

Answer: B


Cash dividends from REITs are taxed as ordinary income. They do not qualify for a maximum rate of 15%, which applies to qualifying dividends from common stock.

Which of the following terms does NOT apply to REITs?

A) Managed.
B) Secondary market.
C) Subchapter M.
D) Redeemable.

Answer: D


A redeemable security is one for which there is no secondary market. The issuer stands ready to redeem if a customer wishes to sell. However, REITs trade in the secondary market and are not redeemable. The real estate portfolio is actively managed and REITs are subject to Subchapter M of the Internal Revenue Code.

Which of the following is an equity security?

A) Collateralized mortgage obligation.
B) Government National Mortgage Association pass-through certificate.
C) Real estate investment trust share.
D) Mortgage-secured bond.

Answer: C


A REIT share is an equity security that represents undivided ownership in a portfolio of real estate investments. The other choices are debt securities.

A trust set up to invest in real estate, mortgages, construction, and development loans that must distribute at least 90% of its net income to avoid paying taxes on the income distributed is called:

A) a unit investment trust.
B) an open-end investment company.
C) a trust indenture.
D) a real estate investment trust.

Answer: D


A real estate investment trust, in order to avoid tax on its income, must distribute 90% of its net investment income to investors.

The similarities between a real estate investment trust (REIT) and a real estate limited partnership include:

A) no tax to the entity if at least 90% of net income is distributed.
B) all of these.
C) centralization of management.
D) flow-through of losses.

Answer: C


Though a real estate investment trust is not established as a limited partnership, both legal entities are established to provide centralization of management. The limited partnership allows for the flow-through of gains, losses, deductions, etc. The REIT may be established as a qualified REIT if 90% of the net investment income flows through to the investor, but never allows losses, expenses, and deductions to flow through.

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