Differentiate Equity Securities - Series 65

1. What is a preferred stock dividend typically described as compared with common dividends?

   A fixed stated dividend (often a stated rate or amount). Preferred dividends are fixed at a predetermined rate or amount, providing predictable income, unlike variable common dividends that depend on company profits.

2. What is convertible preferred stock?

   Preferred stock that can be exchanged for common shares. Convertible preferred offers the option to exchange for common shares at a set ratio, allowing participation in equity upside while providing fixed income.

3. What is an American Depositary Receipt (ADR)?

   A U.S. bank receipt representing shares of a foreign company. ADRs facilitate U.S. trading of foreign stocks by representing ownership in shares held by a U.S. bank, simplifying access to international markets.

4. What is the key difference between common stock and preferred stock in liquidation?

   Preferred has priority over common for assets and dividends. In liquidation, preferred stockholders have a senior claim on assets and dividends compared to common stockholders, ensuring they are paid first up to their par value.

5. Which option best describes the income expectation: common stock or preferred stock?

   Preferred is income-oriented; common is more growth-oriented. Preferred stock emphasizes stable dividend income for yield-seeking investors, while common stock focuses on potential capital growth through earnings reinvestment.

6. What does it mean if preferred stock is noncumulative?

   Missed dividends do not accrue and are not owed later. Noncumulative preferred stock means omitted dividends are forfeited permanently, without obligation for future payment, to limit issuer liability.

7. Identify the term: value of a convertible based on its straight debt characteristics.

   Investment value (bond floor). Investment value establishes a minimum price floor for convertibles based solely on their fixed-income attributes, ignoring the conversion option.

8. What is callable preferred stock?

   Preferred the issuer can redeem at a stated price after a date. Callable preferred gives the issuer the option to repurchase shares at a specified price after a set date, often to refinance at lower rates.

9. What is the conversion ratio?

   Number of common shares received per convertible security. The conversion ratio specifies the exact number of common shares obtainable per convertible unit, determining the equity value upon conversion.

10. What is a key additional risk specific to ADRs compared with U.S. common stock?

    Foreign currency and foreign political/regulatory risk. ADRs expose investors to currency fluctuations and risks from the foreign issuer's home country regulations and politics, beyond standard market risks.

11. What is the typical priority order in liquidation among bonds, preferred, and common?

    Bonds first, then preferred stock, then common stock. Liquidation priority follows capital structure hierarchy, with bonds as senior debt paid first, followed by preferred equity, and common as residual claimants.

12. What is the primary ownership right represented by common stock?

    Residual ownership with voting rights in the issuer. Common stock embodies residual ownership, entitling holders to assets after all debts and preferred claims are satisfied, along with voting rights to influence corporate governance.

13. What is nonparticipating preferred stock?

    Preferred limited to its stated dividend with no extra participation. Nonparticipating preferred restricts dividends to the fixed stated rate, preventing holders from benefiting from excess profits distributed to common stockholders.

14. What is the formula for conversion price given par value and conversion ratio?

    Conversion price $=\frac{\text{par value}}{\text{conversion ratio}}$. This formula derives the effective price per share by dividing the convertible's par value by the number of shares received upon conversion.

15. What is a convertible bond in relation to equity securities?

    A debt security that can be converted into common stock. Convertible bonds combine debt with an equity option, allowing conversion into common stock at a predetermined price to benefit from stock appreciation.

16. Which equity security typically has voting rights: common or preferred stock?

    Common stock. Common stock typically includes voting rights to elect directors and approve major decisions, whereas preferred stock usually lacks such rights to prioritize dividend stability.

17. What is the formula for conversion value of a convertible security?

    Conversion value $=\text{conversion ratio}\times\text{common price}$. This formula calculates the equity-equivalent value by multiplying the shares obtainable by the current market price of the common stock.

18. What is convertible common stock?

    Common stock is not convertible; conversion features apply to other securities. Common stock lacks conversion features, as convertibility is a hybrid attribute typically found in preferred stock or bonds to attract investors.

19. What is the conversion price?

    Implied price per share paid upon conversion. The conversion price represents the effective cost per common share when converting, calculated to set the threshold for profitable conversion.

20. What does it mean if preferred stock is cumulative?

    Unpaid dividends accrue and must be paid before common dividends. Cumulative preferred stock requires that any missed dividends accumulate and be paid in full before any dividends can be distributed to common stockholders.

21. What is participating preferred stock?

    Preferred that may receive extra dividends beyond the stated rate. Participating preferred allows holders to share in additional dividends if common stockholders receive payouts beyond a certain level, enhancing potential returns.

22. What is the main risk to investors of callable preferred stock?

    Call risk: issuer may redeem when rates fall, limiting upside. Call risk exposes investors to early redemption by the issuer when interest rates decline, forcing reinvestment at lower yields and capping price appreciation.

23. In what currency are ADR dividends typically paid to U.S. investors?

    U.S. dollars. ADR programs convert foreign dividends into U.S. dollars for payment, reducing currency conversion burdens for American holders.

24. Which equity security is generally more sensitive to interest rates: preferred or common?

    Preferred stock. Preferred stock behaves like fixed-income securities with perpetual dividends, making its value more inversely sensitive to interest rate changes than growth-focused common stock.

25. What is the role of the depositary bank in an ADR program?

    Holds foreign shares and issues ADRs representing those shares. The depositary bank custodies the underlying foreign shares and issues tradable ADRs to U.S. investors, handling administrative tasks like dividend distribution.

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