29:14
SIE Exam - Equity Securities. Episode 2
Series 7 Guru
Overview
This video explains equity securities for the SIE exam, focusing on common stock, preferred stock, rights, warrants, and American Depository Receipts (ADRs). It details the corporate structure, share types (authorized, issued, treasury), shareholder rights (voting, preemptive rights, dividends), and the differences between rights and warrants. The video also covers dividend dates, current yield calculation, stock splits, liquidation order, control stock regulations (Form 144), and the preferential treatment of preferred stock. Finally, it introduces ADRs as a convenient way for US investors to access foreign securities, highlighting their benefits and associated currency risks.
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Chapters
- Equity securities, including common stock, preferred stock, rights, and warrants, represent ownership in a corporation.
- Corporations are formed with a corporate charter, which defines their governance and the maximum number of shares they can issue (authorized shares).
- Issued shares are those sold to investors, while treasury stock is repurchased by the company.
- Understanding these basic structures is crucial as equity securities form a significant portion of the SIE exam.
This chapter lays the foundation for understanding equity by defining the core components of a corporation and the different types of shares, which are fundamental concepts for the exam.
A corporation is authorized to issue 2 million shares in its charter and has issued 1 million shares to investors.
- Common stockholders are owners with rights, including voting on corporate matters and electing the board of directors.
- Voting methods include statutory (one vote per share per item), cumulative (multiple votes can be pooled for one director), and super voting shares (more than one vote per share).
- Shareholders have a preemptive right to maintain their proportionate ownership when new shares are issued, typically exercised through a rights offering.
- Common stockholders are last in line for liquidation, meaning they are paid only after all other creditors and preferred stockholders.
This section details the rights and risks associated with common stock ownership, emphasizing the importance of voting rights, preemptive rights, and the junior position in liquidation.
A shareholder with 100 shares and statutory voting can cast 100 votes for each of the three board seats, while with cumulative voting, they could cast all 300 votes for a single seat.
- Rights are short-term options issued to existing shareholders, allowing them to purchase additional shares at a price below the current market value, primarily to maintain proportionate ownership.
- Warrants are typically long-term options issued as a 'sweetener' with other securities (like bonds) to incentivize investment, often exercisable at a price above the current market value.
- The key difference lies in their issuance purpose, duration, and exercise price relative to the market price.
Distinguishing between rights and warrants is a common test item, and understanding their distinct characteristics helps in analyzing investment incentives and shareholder privileges.
A company issues warrants with bonds, giving bondholders the right to buy stock at $50 per share for the next five years, even if the stock's market price rises to $70.
- Shareholders have a right to dividends only if they are declared by the board of directors.
- Key dividend dates include the declaration date, ex-dividend date (one business day before record date), record date (shareholder must be on record to receive dividend), and payable date.
- Current yield is calculated as the annual dividend per share divided by the current market price per share.
- Stock dividends and stock splits increase the number of shares but do not change a shareholder's proportionate ownership or the total value of their holdings.
Understanding dividend mechanics and stock distributions is essential for calculating investment returns and recognizing how corporate actions affect share counts and value.
If a stock's record date is October 16th, a purchase on October 15th (the ex-dividend date) will not entitle the buyer to the upcoming dividend payment.
- Control stock is held by officers, directors, or principal stockholders (owning 10% or more).
- Sales of control stock are regulated under SEC Rule 144, requiring the filing of Form 144 before or at the time of sale.
- The amount that can be sold is limited to 1% of outstanding shares or the average trading volume over the last four weeks, whichever is greater.
- Unregistered stock, often received as compensation, has a holding period (e.g., six months) before it can be sold, and is sometimes referred to as 'legend stock'.
This section covers regulations designed to prevent market manipulation by large shareholders, which is a critical compliance aspect tested on the SIE exam.
An executive owning 15% of a company's stock must file Form 144 to sell shares, limited to 1% of the total outstanding shares or the average trading volume, whichever is higher.
- Preferred stock offers preferential treatment over common stock in dividends and asset distribution during liquidation.
- Preferred stockholders typically do not have voting rights.
- Key types include non-cumulative (missed dividends are lost) and cumulative (missed dividends accrue and must be paid before common dividends).
- Convertible preferred stock can be exchanged for a specified number of common shares.
Understanding preferred stock's unique characteristics, especially its priority and different forms, is vital for comparing it with common stock and assessing investment risk and return.
A company must pay all accumulated unpaid dividends on its cumulative preferred stock before it can distribute any dividends to its common stockholders.
- ADRs facilitate US investors' access to foreign securities by trading them on US exchanges.
- They represent ownership of shares in a foreign company held by a US bank, simplifying transactions and currency conversions.
- ADRs offer diversification benefits but still carry currency exchange risk.
- They are a convenient way to invest in foreign markets compared to directly trading on foreign exchanges.
ADRs are a practical tool for international investing, and knowing how they work and their associated risks is important for understanding global market access.
An ADR for a Japanese company allows a US investor to buy shares on the Nasdaq, with dividends converted from Yen to Dollars by the ADR sponsor bank.
Key takeaways
- Equity securities represent ownership in a corporation, with common stock offering voting rights and potential for growth, while preferred stock offers priority in dividends and liquidation.
- Understanding the difference between authorized, issued, and treasury stock is fundamental to corporate finance.
- Shareholder rights, such as voting and preemptive rights, are crucial protections for owners, but common stockholders are the last to be paid in liquidation.
- Rights and warrants are options to buy stock, differing in their issuance purpose, duration, and exercise price relative to market value.
- Dividend payments are contingent on board declaration, and understanding the sequence of dividend dates (especially the ex-dividend date) is critical for investors.
- Sales of control stock by insiders are regulated to protect the market, requiring specific filings and adhering to volume limitations.
- Preferred stock provides priority over common stock but usually lacks voting rights; cumulative preferred stock ensures that missed dividends are eventually paid.
- ADRs simplify foreign stock investment for US investors, offering convenience and diversification but retaining currency risk.
Key terms
Equity SecuritiesCommon StockPreferred StockAuthorized SharesIssued SharesTreasury StockVoting RightsPreemptive RightRightsWarrantsDividendEx-Dividend DateRecord DateControl StockForm 144Restricted StockCumulative Preferred StockConvertible Preferred StockAmerican Depository Receipt (ADR)Current Yield
Test your understanding
- What is the primary difference between common stock and preferred stock regarding shareholder rights and claims?
- How do preemptive rights allow common stockholders to protect their ownership stake, and what mechanism is typically used?
- Explain the key distinctions between rights and warrants in terms of their purpose, duration, and exercise price.
- What are the four key dates associated with dividend payments, and why is the ex-dividend date particularly important for investors?
- Under what circumstances can an individual sell control stock, and what are the limitations imposed by SEC Rule 144?
- How does cumulative preferred stock offer greater protection to investors compared to non-cumulative preferred stock?
- What is an American Depository Receipt (ADR), and why would a US investor choose to invest in one?