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Series 7 Prep - Equity Securities

6. Equity Securities - Rights and Warrants

Now that you've had a chance to go through the questions on your own, let's work through them together. And I'll be explaining and demonstrating how to approach and answer these questions correctly. So, first question: All the following statements regarding preferred stock are true, except this means we're looking for the false answer. So let's look at what we know about preferred stock. Preferred stock is the thing that people will pay for. They have a stated interest rate, and they will receive dividends before the common stock. And they'll get paid out before common stock if the company goes under. So let's have a look. In most cases, dividends are paid semiannually. Corporations must pay preferred dividends. Preferred dividends are paid before commons. So we know that one is a true statement. So that means that's a bad answer for this case. Preferred stock growers are compensated before common stock growers. That is also true. We just stated that. So now it comes down to either A or B. Dividends are now paid on a quarterly basis. They are quarterly dividend bonds, which we'll learn at a later time. Those are paid semiannually. So A is also a true statement. So B is the answer that is false. going on to the second question. All right, so here's a second question. XYZ Public is offering 100,000 units. So that's an important price of $200 each, which could be important. Each unit will include two shares of preferred and a warrant to buy one additional share of common. Full warrant will give the ability tobuy a common at $5 share. If they're all exercised, what will happen? Let's have a look. So for every one unit, that's going to equal two units preferred. So if we know that you're going to have two preferred for every one unit, and there are 100,000 units right there, we know there are going to be 200,000 preferred shares. So let's go up and look for that first. The only two that have 200,000 are A and C. So now let's see the last part. So for every one unit, it will have a warrant that can become one common share. That means that for every 100,000 units, there could be 100,000 common shares. Excellent. So we go back in between A and C. A has 200 and 100,000 common shares. Excellent. We got it right. All right, let's move on to the next question. If a company goes bankrupt and its assets are liquidated, then the last group of investors to be paid is all right. So we've talked about this a little bit. We know that preferred will be paid before common, and commons are lowest on the totem pole. That one's. a quick one. D is going to be the correct answer. Always common. The Stockholms are always last. Next question. If an investor wishes to receive a dividend on a stock they already own, that is key. We have to look at that. They already own the stock, so it would be the earliest that they could sell the stock and still receive the dividend. So they actually want to receive thedividend on a stock they hold, butthey're also looking to sell the stock. So when could they sell it? still get the dividend at the same time. So we know that we have a record date, and you have to be on the record as of that date in order to get the dividend. So the day after the record date would be the first date that whoever is buying from our investor would have to settle the trade. So, if we think back, let's set a couple of dates. So let's say this is the 18th. The 19th would be the day after we have the 17th, the 16th, and the 15th. So if this is a settlement, we have plus three, plus two, plus one. So if it's traded here, it will settle here. We don't want that. We want to trade here. So that settles it. So we still get the dividend, and this is our exdividend date. and that's exactly what it is. It's going to be traded without the dividend date. So our answer for this one is going to be C, the X state. Next question. Which two statements are true? So this is a common type of test question that you will see on the test, where they have you pick out the two true statements. So let's have a look. I like to jump down and look at my answers first, through A through D, to see what I need to prove. It looks like one and two. So we have to find a true statement betweenthese two and a true statement between these two. So let's look at the first one first. Common dividends are paid quarterly. Common dividends are paid semi annual.They are paid quarterly. That's the one thing that we've talked about already. Dividends are paid quarterly. Excellent. So that means we knew that onehas to be an answer CND cannot. So as we look at the next one, three to four common dividends are paid on outstanding shares. Common dividends are paid on issued shares. So we talked about this very briefly. Issued means that these are the ones that are issued when the company goes public. But if there are any shares that the company buys back and holds as treasury stock, those will not get paid any dividends. So outstanding shares are actually, if we did a calculation, issued shares minus Treasury stock, which will equal outstanding shares. And these outstanding shares are the ones that do get paid the dividend. So three, one, and three will be our correct answer. Next question. Why has the company declared a rights offering on January 10th? Under the offer, you need ten rights to subscribe for one new share at a price of $19. Fractional shares. We round it up. So we saw one of these earlier. If your client owns 112 shares, he wants to subscribe to this offer. The current price is $30. What can the customer buy? So our customer has 112 shares, and we know that for every one share you have, you get one, right? So this guy will have 112 rights. So with 112 rights, it says that you get to have one for every ten rights you can get a new share.So divide this by ten. This is 11. 2 shares are what this guy would be able to buy. But it does tell us that any fractional shares can be rounded up. So that means this gets bumped up to twelve shares that we can purchase. All right, so let's see twelve shares. We have two that have twelve shares. So, A, and I notice you're looking at 228 versus 372. Now, we know that we can buy it for $19 because that's what the terms of the right offer equal. So we multiply our twelve shares by the $19 per share we'll have to pay, and the result is eight one. We do quick math. 228 is our total price. So B will be our correct answer. So, with this question, your client will be able or required to vote on all of the following issues as an owner of common stock, except let's take a look. A merger with another company sounds pretty serious. Convertible securities and whether to accept an offer for a company's shares or declare a stock dividend So, for this one, any time that there are material events that are happening to a company, including when your clients could be, their ownership could be diminished or diluted, meaning there could be more shares that could eat into their earnings, et cetera. Anything like that would have to be voted on. So declares the merger. Yes, that was something that you'd have to vote on. Convertible securities are what would result in new shares being issued. So that would need to be voted on, along with whether or not to accept a 10-man draft. So this is when another company comes in and wants to buy out your company out.That would have to be voted on as dividends. No, dividends are not going to have to be voted on. Otherwise, guess what? All investors would prefer to have consistent and high dividends. So D is your answer on that one. If your customer owns 1000 shares of common stock and ZZ, this could dilute his shareholder equity. So that's what we just talked about. Diluting your shareholder equity will eat into your proportionate ownership. So we're looking at a couple of different things going on down here. So let's have a look at what we want to prove. So let's just look at one. One says that the company declares a 15% stock dividend. That helps everybody. So that means that will not affect your shareholder equity, so that will not dilute it. So that's a bad answer. So now that means we get to take out anything that has a one in it. Now, we notice that four is in both B and C, so that means that one is a good answer and we don't even need to look any further. Let's just look at two and three because that's what we need to compare against. All right, so to speak, declares a convertible preferred stock, which trades at a premium or as a three-for-one stock. So it's a three-for-one stock split. Everyone still has the same proportionate ownership, just different numbers of shares at different values. So that one is okay, but not what we're looking for. Two is the correct answer. So, two and four for this one. The next question says that I am entitled to the dividend that XYZ declared on Tuesday, June 20. So the date is important; the record date is on Friday, June 30, payable on July 10. A new purchase would need to be on the books as of what date? Basically, they're getting paid to receive the dividendis what they're getting at.So it's all about the record date. You have to be on the books as of the record date in order to get the dividend. So this question is purely about being able to dive in and get this information. They tell us right there that June 30 is when the payable date is, and that's going to be our correct answer. June's next question talks about common and preferred. So which of the following are true? So that's key. We're looking for a true balance between common and preferred. All right, so let's look down really quick. one and two. We have to pick one true statement from each of those two. So let's look at the first two. Preferred stock dividends are paid after common stock dividends or before common stock dividends. so preferred, hence the name. They get preferential treatment, so they get paid first. That means we're looking for one of these two. So these are bad answers. So we're going to look at the next two numbers between three and four. So preferred stockholders have claimed assets prior to common stockholders. Common stockholders have prior So in this case, again, as is common, they're always at the bottom of the pile. So the preferred get paid firstif the company goes to bankruptcy. The correct answer here is going to be C. The next question says common stockholders have all of the following rights except one, so we're looking for the false one. Again, it's very important to make sure we read the full question. All right, they do have a right to receive the dividend when it's declared. So that is something they do get to do. right to manage. I'm not quite sure where we're going with that one. Let's keep going. right to transfer shares. That means they get to trade. They can do that, and they get the right to vote. We talked about the different ways you could vote. The right to manage is something that they don't get to vote on because this would be like the day-to-day operations. We're not going to be able to have individuals that are stockholders come in and vote on those. That's why there is a board of directors. The board of directors takes care of the day-to-day operations, and we as stockholders vote them in for that. All right. When purchasing a warrant, it is normal and expected that the exercise price for the warrant is set as an issuance price. So we talked about the difference between a right and a warrant. Rates normally have their exercise price at a lower level than the current market price, whereas warrants normally have their exercise price at a premium to the current market, mainly because a warrant has extended time frames where the stock could potentially grow and be higher than the exercise price. And then customers will be excited to take advantage of that. So let's have a look at these answers. a premium to the current market price. That sounds pretty good. The market price of the common stock, not a discount. That's what a right is. So that's not the right answer. and any price designated, so not any price. They're normally going to have a set price. So A will be the correct answer for this question. All right, last question. Op has declared a dividend on June 15 with a record date of Tuesday, August 1, if the stock is purchased on Monday, July 31. Which of the following statements are true? Excellent. So we're looking for two true statements. Again, looking down the answers, it looks like one or two will be a good answer and three or four will be a good answer. So let's look through these. So one and two say stock is purchased for cash settlement and cash settlement.All right. So a cash settlement is something that is a little bit odd. We are aware that the conventional wisdom states that if you buy stock, you must settle within three business days. So it's trade plus three business days, and that equals settlement on a cash settlement. That's basically saying you're going to have the cash available today to settle on your trade. So that's basically the same day. So let's go back. If the record date is on a Tuesday, we buy it on a Monday, and it's the day right before cash sellers will receive the dividend because they're able to settle that same day. So two is our correct answer in this one, so we can get rid of A and B. So now we look at three and four. Regular way is: will they receive the dividend if they buy the stock in the regular way? Well, if they buy it the day before, they're too late because they have to have it settled as of the first. If Tuesday is the first, that's when it has to settle for our record date. That means Monday was the 31st; Sunday was the 30th. Saturday was the 29th. Friday was the 28th, so Monday counts. So this would be plus three. This will be plus two, plus one. So Saturdays and Sundays don't count. So Thursday, the 27th, So if they wanted to get the dividend the regular way, they would have had to buy it on this date, so they will not receive the dividend. So two and three are our correct answers for that one. Here we go. All right. So those questions conclude the information about the equity security section of this preparation material and videos. Now, what we would like you to do is continue by selecting the next video from the course, which is about equity securities. Wrap up to discuss next steps.

7. Equity Securities - Suitability and Formulas

So the last section that we'll be discussing together in equity securities is about the suitability and specific formulas that you may need to know for these types of questions. So suitability you have to think of whya customer would want to buy these. As a stock broker, you're going to need to know a little bit about your customer before you start making recommendations to them. So think of this. When you have a common stock, most people think they buy a stock in a company because they want the value to go up. We call that growth and depreciation. This is also known as a "bullish" strategy because when we talk of bulls and bears, bulls are things that are going to be on the upward trend in the stock market. So, this is bullish. Now it is important to understand the differences between a small-cap company and a large-cap company. Small cap are smaller companies and large capare large companies, large and established companies. So think of Walmart and Exxon Mobile compared to a smaller company that may just be in startup mode. A smaller company may have a little bit more risk involved because it has been proven it hasn't been around the block for a couple of years. A large company is going to be; it would take a lot of things happening for a huge company like Walmart or Bank of America—something like that—not to exist anymore. The second thing is for preferred stock. So we talked a little bit about how preferred stock has aspects that are similar to bonds because it has a fixed rate and pays a more regular dividend. So people who would want to buy preferred stock would want to do so because they look at the potential growth of the company, but they're also more important, in that they're more attracted to the fact that there's going to be a regular stream of income. So they try to balance that out. Now rights and warrants—we talked about these. This offers you the capability of getting new shares. For people who already own the stock, warrants are something of a sweetener. So if you buy a bond, you may get a warrant as well. One thing that they love to test on the exam is the fact that if you have a custodial account for a minor, for example, if I had a custodial account for my son. if I had rights or warrants. I have to either exercise those or sell them because I have to, as a custodian, act in the best interest of the owner, who is actually a minor. So you have to basically exercise or sell them. Now, if you think of ADRs, ADRs are normally associated with something along the lines of growth, like a common stock, because it is a common stock. It's just a company that's overseas, right? So you have this investor that may want to buy this and has the potential for upward growth. But you have to be wary of the international exposure because if they're well diversified in the US, Market; that's fine. They may want to branch out, but watch out for international risks as well as currency risks. Because if you're buying something that is going to be in a different currency, it may be hard to get that back into the US. Currency. You could lose some potential buying power and other things that go along with currency risk. So just be aware of that. Now, the different formulas and calculations that you kind of need to know For the Series Seven exam, when we're specifically talking about equity securities, the first one that we're going to look at is the dividend yield, or how much am I really getting as a return on my investment, right? So if I paid X amount of dollars for a stock, those dividends that come in are my return on investment. So, instead of just one dividend, add up your annual dividend payments to see how much you get paid each year. because a lot of times they may say that the first quarter dividend was twenty-five cents. And then they may ask you: What was the yield? So keep in mind that these are done on a quarterly basis. So you have to divide that by four to get your annual. So your annual fee would be a dollar up here. And then you divide that by whatever the market price of the stock is. So let's say the stock is $9. You could add that in and do the one divided into nine in order to get your annual dividend or your dividend yield. And that's how you would work on that type of problem. Okay, the next calculation that we are going to try to make sure we know about is the price-earnings ratio. So this is basically talking about how much the company earns as income. So we're talking about the balance sheet and income statement compared to the price of stock. So you take the market price of the security, $10, and divide that by whatever the earnings were per share. So let's say it was $2 earnings per share. That's five to one. So that's a five-to-one ratio of earnings from the price to earnings. So the next steps for this section are that there's going to be a PDF file that's going to be contained on the Udemy page, and the file is going to be labelled as Equity Securities Practice Questions. It is a PDF. Go ahead and download that. and what you're going to want to do is work through the questions on your own. Mark what you think the answer is. If you need to do work on the page, great. If you want to print them, you can because they are in PDF format. Work through those questions, and then once you're finished, the next file that you see on Udemy is going to be a video with me working through these problems, and it's going to be labelled as "Equity Practice Questions Explained." That way, we can make sure that you're getting the right thought process. After you've gone through the practise questions, then we'll be ready to do a wrap-up on this section and talk about the next steps.

Equity Securities - Practical Application

1. Equity Securities - Practice Questions EXPLAINED

Alright, the next section that we're going to look at in the equity securities is other equity, specifically rights and warrants. So let's first talk about rights. Basically, in a nutshell, rights allow current stockholders to buy more shares because they're going to be awarded additional rights. So for example, it shows up here. As an example, the holder of this right may purchase new shares. With these terms, ten rights plus $10 equals one new share of ABC Corporation. which means if you hold ten rights in your hand plus a ten dollar bill, you can turn that into a new share of the ABC Corporation. So let's talk a little bit more about the characteristics. specifically with rights. They are considered short-term, and normally you have a very specific time frame of when you can buy or take advantage of these rights and make them work for you. So there is a set price for a set period of time. So in our example, it says $10. So you get the ten rights plus $10. You get one new share. But in most cases, it will say this expires in four weeks. So investors would have to jump on this fairly quick. This is a preemptive right given to existing stockholders to buy more. One thing that is always constant is that any investor who holds a share of common stock will receive one right for every share owned. which means if you have 200 shares, you will receive 200 rights. Then the terms of the right offering will tell you how many rights are required to buy a new share of stock. So in our example, ten rights plus $10 In here, I say 20 rights to buy one share at $20. Now, the price itself is normally set at a discount to where the current market is. So you benefit as a holder of a right; you actually benefit. So you have to use your money to get new stock. It is normal for the exercise price to be lower than the market price. So in our example, you have $20. Let's say the market is currently at $24. So technically, if you have these rights, you can turn around and take advantage of this, buy it at $20, turn around and sell it at $24, and make a profit. So these types of things are very attractive to customers. Rights owners don't always have to exercise their rights. They could actually do other things. They could sell them to someone else or, if they really decided to, they could allow them to expire. It doesn't make sense because if you can sell them to somebody else for value, you might as well just do that. But exercise is when you have extra money and you want to buy those new shares. You want to take advantage of that and increase your position. Next, we're going to look at just a quick sample question in regards to a rights offering. The OMG Corporation is going to issue new stock by way of a rights offering. So this is how the company is going to generate more capital through a rights offering. Terms of the offerings state that ten rights plus $10 are required to buy one new share. so very similar to what we said. Now, they do tell us some specific terminology. Any fractional shares can be rounded up to buy additional shares. We'll show what that means. OMG is currently trading at twelve. So that's the difference between the $10 here and the $12 in the market price is.Now, our investor owns 84 shares and wants to exercise their rights. How many new shares So this indicates they were asking how many new shares he will be able to purchase and how much it is going to cost him. All right, so we take our 84 shares, and remember, we get one right for every share. So we get 84, and as the saying goes, for every ten rights you can get a new share. This guy, we just divide this by ten andhe has basically he could buy 8.4 shares. This is where the fractional part comes into play because they say that any fractional shares can be rounded up. So, instead of buying 8.4, you get a round up because you can't buy half a share. And that means he gets to buy nine shares as part of this rights offering. So at nine shares, you look at how much it would cost him as part of the offering. It's going to cost him $10. So nine shares at $10 apiece will give us the answer if B is the correct answer. Now, you'll notice some of the bad answers are here, but this is not one of them. The Series Seven exam is notorious for this. They take the nine shares; that is a partial, valid answer; but then they multiply it by twelve to get the 108. They take the eight shares as if you're rounding down and multiply that by twelve to get to the other 96. And then they just use the eight shares, not rounding, times ten. So they are notorious for making it so that some answers that are partially correct are up there because they know that some people that are taking the test may omit different steps as they work through these. So be very careful to ensure that you understand exactly what work you need to do for that question. All right, so the next section we're going to look at very quickly is warrants. Most of the time, when we talk about warrants, they like to use it as a comparison between rights and warrants. warrants are very similar. The holder of a warrant can buy a share of a particular company in a time frame, and normally it's longer. So, five years for $40 a share. So it is a long-term right to buy something. It is a preset price within that period of time, butagain, it could be up to five to ten years. So it's stretched out over time. So there is a lot of time value in here because it is usually attached to a bond. And when you say that it's added as a sweetener, what they do is, as you buy a bond, a company may add on this little thing extra that's called the warrant that down the road allows you the opportunity to buy stock at a specific price. Now, the hope is that as a customer, since it would cost you $40 a share in five years, you're hoping that the stock would climb or appreciate much more than $40 because then you can lock in your purchase price at $40 and then turn around and sell it for a profit to somebody else. Now, when they do offer out these warranties, they normally refer to them as units, which means you're buying a package of something almost like a combo meal at a fast food place. The reason they do it is because of its marketability as a sweetener aspect.If you have two bonds to purchase and one of them offers you the chance to buy stock at a possibly killer deal in the future, people are going to jump on that. So it's a way that companies can help increase the marketability of their bonds, and then the exercise price of the warrant is normally set above what the current market price is. Again, I'm hoping for the appreciation and the long-term outlook. So talking about the time value, hopefully that can increase in value over time, right? It will be a good deal at a later point in time, just like the rights. You can exercise these, sell them, or let them expire. Allowing them to expire may make more sense on a warrant because it will not make sense to exercise this if the stock has dropped below $40 per share. It would make more sense if the stock were higher. So it is possible that you may want to let a warrant expire. Alright, so the quick comparison and little chart to help you out are necessary because again, you may see one or two questions specifically asking the differences between the rights and a warrant. So, where the exercise price is, one of the key aspects of short-term versus long-term investing is the time horizon. As a result, the terms established as part of the warrant or rights will be discounted to the market in order to make it a good deal. The warrant is going to be a premium to the market, so over time it can become a good deal. All right, so how are rates attained? You have to be a current shareholder, and then you get one right for every share. And warrants are normally used as a sweetener or an add-on to a bond to entice people to come get their bonds. The value derived from this is intrinsic value because it's already built in because you get to buy the stock at a discount over here with a warrant. It's the fact that you have time; you have value that increases over time, and that's what's going to make a difference. So we've looked at a couple of these other equities. Be prepared when we go and do some practise questions together. You will see some of these. Let's go on to our next section.

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