Chapter 6: Stocks

Question 1

Adjustable rate preferred stock has a dividend that adjusts according to _________

Answer 1

Prevailing interest rates

Question 2

ABC is issuing new shares through a rights offering. If a new share costs $16 plus 4 rights and the stock trades at $20, what is the theoretical value of a right prior to the ex date?

• A. $0.20
• B. $0.80
• C. $1.00
• D. $1.20

Answer 2

B. $0.80

• The stock is trading with (cum) rights so you need to use the cum rights formula:
• (M - S) / (N + 1)
• ($20 - $16) / ($4 + $1)
• $4/$5 = $0.80

Question 3

ABC is offering 2,000,000 shares of its common stock to the public; 1,500,000 shares are authorized but previously unissued, and insiders of the company are selling the the other 500,000 shares. Which of the following are TRUE about this offering?

• I. the EPS of ABC will increase
• II. the EPS of ABC will decrease
• III. the number of outstanding shares will increase by 500,000
• IV. the number of outstanding shares will increase by 1,500,000
• A. I and III
• B. I and IV
• C. II and III
• D. II and IV

Answer 3

D. II and IV

• The offering is a combined, or split, offering.
• The 1.5 million shares previously issued are a primary offering, and the 500k shares are a secondary offering.
• When considering the earnings per share will increase or decrease, you can assume the company earns the same amount of money.
• Now the same amount of money will be divided among 1.5 million more shares.
• Therefore, you can deduce EPS will decrease, not increase.

Question 4

A client owns 400 shares of ABC common stock at $33 per share. ABC previously declared a 10% stock dividend. Assuming no change in the market price of ABC prior to the dividend, what is the client’s position after the dividend?

• A. 400 shares at $30
• B. 440 shares at $33
• C. 400 shares at $36.30
• D. 440 shares at $30

Answer 4

D. 440 shares at $30

• The client’s overall value of investment doesnt change. The client gets a 10% dividend, so he gets 10% more shares.
• 400 + 10% [40] = 440 new number of shares
• Overall value of investment = 400 * $33 = $13,200
• $13,200/440 = $30 per share

Question 5

If ABC preferred stock ($100 par) is convertible into common stock for $25, what is the conversion ratio?

• A. 1 share
• B. 4 shares
• C. 25 shares
• D. 100 shares

Answer 5

B. 4 shares

• Conversion ratio = par value / conversion price
• Conversion ratio = $100 / $25 = 4 shares

Question 6

The amount over par value that an issuer receives for selling stock is called ________.

Answer 6

Paid in capital