Overview
Equity securities represent ownership interests in corporations and are a major focus of the Series 7 exam. This guide covers common and preferred stock characteristics, rights and warrants, American Depositary Receipts (ADRs), and dividend mechanics. Mastering these concepts requires understanding both the features of each security type and the calculations associated with them.
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Common Stock
Key Concepts
Common stock represents the most basic form of corporate ownership. Common stockholders bear the greatest risk but also have the greatest potential for reward.
Shareholder Rights:
• Voting rights on major corporate matters (board elections, mergers, new share issuances)
• Preemptive rights to purchase new shares before the public
• Residual claim on assets in liquidation (paid last)
• Right to receive dividends (not guaranteed)
• Right to inspect corporate books and records
Voting Methods
| Feature | Statutory Voting | Cumulative Voting |
|---|---|---|
| Votes per share per seat | 1 vote per share | Shares × Number of open seats |
| Concentration allowed? | No | Yes |
| Benefits | Majority shareholders | Minority shareholders |
> Example: An investor owns 100 shares. There are 3 open board seats.
> - Statutory: Cast up to 100 votes per seat (300 total votes, but spread across seats)
> - Cumulative: 300 total votes that can ALL be placed on one candidate
Key Formulas
Book Value Per Share:
> Book Value Per Share = (Total Stockholders' Equity – Preferred Stock Equity) ÷ Common Shares Outstanding
Stock Split Effects (2-for-1 Example):
• Shares outstanding: doubles
• Stock price: halved
• Total market capitalization: unchanged
Authorized vs. Issued vs. Outstanding Shares
• Authorized shares – Maximum shares allowed by the corporate charter
• Issued shares – Shares that have been sold to investors
• Outstanding shares – Issued shares minus treasury shares (shares repurchased by the company)
• Treasury shares – Repurchased by the company; carry no voting rights and no dividends
> Formula: Outstanding = Issued − Treasury
Key Terms
• Common Stock – Basic ownership unit of a corporation
• Statutory Voting – One vote per share per open seat
• Cumulative Voting – Total votes concentrated on one candidate
• Preemptive Right – Protection against ownership dilution
• Book Value Per Share – Net asset value attributable to each common share
• Treasury Stock – Shares repurchased and held by the issuing company
• Stock Split – Increases shares outstanding while reducing price proportionally
• Reverse Stock Split – Decreases shares outstanding while increasing price proportionally
⚠️ Watch Out For
• Stock splits do NOT change market cap or a shareholder's total investment value — only price and share count change
• Cumulative voting benefits minority shareholders, not majority — don't confuse the two
• Treasury shares do NOT vote and do NOT receive dividends — they are issued but NOT outstanding
• Common stockholders are LAST in liquidation — after secured creditors, unsecured creditors, and preferred stockholders
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Preferred Stock
Key Concepts
Preferred stock is a hybrid security with characteristics of both bonds and common stock. It pays a fixed dividend and has priority over common stock in dividends and liquidation, but typically has no voting rights.
Types of Preferred Stock
| Type | Key Feature |
|---|---|
| Straight (Non-Cumulative) | Fixed dividend only; missed dividends are lost forever |
| Cumulative | Missed dividends accumulate as dividends in arrears; must be paid before common dividends |
| Participating | Receives fixed dividend PLUS shares in additional profits with common stockholders |
| Callable | Issuer may redeem at a set call price; benefits the issuer |
| Convertible | Holder may exchange for common shares; benefits the investor |
| Adjustable-Rate | Dividend resets periodically based on a benchmark (e.g., T-bill rate); reduces interest rate risk |
Key Formulas
Annual Dividend:
> Annual Dividend = Par Value × Dividend Rate
> Example: $100 par × 6% = $6.00 per year
Quarterly Dividend:
> Quarterly Dividend = Annual Dividend ÷ 4
> Example: $6.00 ÷ 4 = $1.50 per quarter
Conversion Ratio:
> Conversion Ratio = Par Value of Preferred ÷ Conversion Price
> Example: $100 par ÷ $25 conversion price = 4 shares of common stock
Key Terms
• Preferred Stock – Fixed-income equity with dividend priority over common
• Dividends in Arrears – Accumulated unpaid dividends on cumulative preferred
• Call Price – The price at which the issuer can redeem callable preferred
• Conversion Ratio – Number of common shares received upon conversion
• Participating Preferred – Shares in additional dividends beyond the fixed rate
• Adjustable-Rate Preferred – Dividend rate tied to a benchmark index
⚠️ Watch Out For
• Callable preferred benefits the ISSUER (they retire expensive debt when rates fall); convertible preferred benefits the INVESTOR
• Non-cumulative preferred: missed dividends are gone forever — no catch-up payments
• Cumulative preferred does NOT guarantee dividends will be paid — it only guarantees that unpaid dividends accumulate and must be paid before common dividends
• Preferred stockholders generally do NOT vote — don't confuse with common stockholders
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Rights and Warrants
Subscription Rights
Rights are short-term privileges granted to existing common stockholders allowing them to purchase newly issued shares at a discount to the current market price, protecting against dilution.
• Typically expire in 30 to 45 days
• Issued on a pro-rata basis (proportional to existing ownership)
• Can be sold in the secondary market if the holder doesn't want to exercise them
Rights Valuation Formulas
Cum Rights (Rights-On) — Stock includes the right:
> Value of One Right = (Market Price – Subscription Price) ÷ (Number of Rights to Buy One Share + 1)
Ex-Rights — Stock trades without the right:
> Value of One Right = (Market Price – Subscription Price) ÷ (Number of Rights to Buy One Share)
> The "+1" is ONLY used when the stock is trading rights-on (cum rights)
Warrants
Warrants are long-term options issued by a company giving holders the right to purchase stock at a specified exercise price.
| Feature | Rights | Warrants |
|---|---|---|
| Duration | Short-term (30–45 days) | Long-term (5–10 years or perpetual) |
| Exercise price | Below market price (at discount) | Above market price at issuance |
| Purpose | Prevent dilution for existing shareholders | Sweetener attached to bonds or preferred stock |
| Issued to | Existing shareholders | New investors (bond/preferred buyers) |
Intrinsic Value of a Warrant:
> Intrinsic Value = Current Market Price – Exercise Price (if positive; otherwise $0)
> Example: Stock at $60, Exercise Price $50 → Intrinsic Value = $10 (in-the-money)
Key Terms
• Subscription Right – Short-term privilege to buy new shares at a discount
• Rights-On (Cum Rights) – Stock trading with the right included in the price
• Ex-Rights – Stock trading without the right; rights trade separately
• Warrant – Long-term call option issued as a sweetener to bond offerings
• Exercise Price – The price at which a warrant can be used to buy stock
• Intrinsic Value – The in-the-money amount of a warrant
⚠️ Watch Out For
• Rights protect shareholders from dilution — always issued to existing shareholders
• Don't confuse rights and warrants: rights are short-term and discounted; warrants are long-term and above market price at issuance
• When stock goes ex-rights, the stock price drops by the theoretical value of one right
• Remember the "+1" in the cum-rights formula — omitting it is a common calculation error
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American Depositary Receipts (ADRs)
Key Concepts
ADRs allow U.S. investors to invest in foreign companies without dealing directly with foreign exchanges or currencies. They trade in U.S. dollars on U.S. exchanges.
How ADRs Work:
1. A foreign company's shares are held by a U.S. depositary (custodian) bank abroad
2. The bank issues ADR certificates representing those shares
3. ADRs trade on U.S. exchanges (NYSE, NASDAQ) in U.S. dollars
4. The depositary bank collects foreign dividends, converts them to USD, and distributes them to ADR holders
Sponsored vs. Unsponsored ADRs
| Feature | Sponsored ADR | Unsponsored ADR |
|---|---|---|
| Foreign company involvement | Yes — company cooperates | No — bank acts independently |
| SEC filing assistance | Company assists | Bank handles alone |
| Number of ADRs for one company | Usually one | Multiple may exist |
| Investor relations | Company participates | Limited involvement |
Key Risks of ADRs
• Exchange Rate (Currency) Risk – If the foreign currency weakens vs. USD, the ADR value and dividends decrease in dollar terms
• Political Risk – Instability in the foreign country
• Limited Information Risk – Foreign companies may have different disclosure standards
Key Terms
• ADR – U.S. dollar-denominated certificate representing foreign company shares
• Depositary Bank – U.S. bank that issues and administers ADRs
• Exchange Rate Risk – Risk that foreign currency fluctuations affect USD value
• Sponsored ADR – Created with foreign company's cooperation
• Unsponsored ADR – Created by a depositary bank without the foreign company's involvement
⚠️ Watch Out For
• ADR investors still face currency risk even though they buy and sell in USD
• The depositary bank handles ALL currency conversion — investors do not exchange currency themselves
• Multiple unsponsored ADRs can exist for the same foreign company; only one sponsored ADR typically exists
• ADRs allow foreign investment but do NOT eliminate foreign company risk
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Dividends and Corporate Actions
The Four Key Dividend Dates
| Date | Description | Key Rule |
|---|---|---|
| Declaration Date | Board announces dividend | Dividend becomes a corporate liability |
| Ex-Dividend Date | First day buyer does NOT get dividend | 1 business day before record date |
| Record Date | Company identifies eligible shareholders | Must be on record by this date |
| Payment Date | Dividend is distributed | Occurs after record date |
T+2 Settlement and the Ex-Dividend Date
Because equity trades settle in T+2 (trade date + 2 business days):
• To receive the dividend, you must buy the stock at least 1 business day before the ex-dividend date
• If you buy on or after the ex-dividend date, the seller receives the dividend
> Memory Tip: "Ex" means "without" — buying on the ex-date means you buy the stock without the right to receive the upcoming dividend
Stock Dividends vs. Cash Dividends
| Feature | Cash Dividend | Stock Dividend |
|---|---|---|
| Form of payment | Cash | Additional shares |
| Effect on total investment value | Value leaves the company | Total value unchanged |
| Effect on share price | Price drops by dividend amount | Price adjusts down proportionally |
| Tax event | Yes (taxable when received) | No (taxable when shares sold) |
Stock Splits vs. Reverse Stock Splits
| Action | Effect on Shares | Effect on Price | Why Companies Do It |
|---|---|---|---|
| Forward Split (e.g., 2-for-1) | Increases | Decreases | Make shares more affordable for investors |
| Reverse Split (e.g., 1-for-5) | Decreases | Increases | Meet exchange minimum price requirements |
> In both cases, total market capitalization is UNCHANGED
Key Terms
• Declaration Date – Date the board formally announces a dividend
• Ex-Dividend Date – First date a stock trades without the dividend
• Record Date – Date used to identify shareholders entitled to the dividend
• Payment Date – Date dividend funds are actually distributed
• Stock Dividend – Distribution of additional shares instead of cash
• Reverse Stock Split – Consolidation of shares to increase stock price
⚠️ Watch Out For
• Ex-dividend date is 1 business day BEFORE the record date — not the same as the record date
• Stock dividends and stock splits do NOT change the total value of a shareholder's investment — only the number of shares and price per share change
• Reverse splits are NOT a positive sign — companies typically use them to avoid delisting from an exchange
• Buy BEFORE the ex-date to receive the dividend; buying ON the ex-date means you miss it
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Quick Review Checklist
Use this checklist to confirm you're ready for exam questions on equity securities:
Common Stock
• [ ] Know the difference between statutory and cumulative voting — and which benefits minority shareholders
• [ ] Understand preemptive rights and their purpose (anti-dilution protection)
• [ ] Know the liquidation priority: secured creditors → unsecured creditors → preferred stockholders → common stockholders last
• [ ] Calculate book value per share using the formula
• [ ] Distinguish authorized, issued, outstanding, and treasury shares
• [ ] Know that stock splits don't change total market cap
Preferred Stock
• [ ] Know all preferred stock types: straight, cumulative, participating, callable, convertible, adjustable-rate
• [ ] Understand dividends in arrears (cumulative preferred only)
• [ ] Remember that callable benefits the issuer; convertible benefits the investor
• [ ] Calculate quarterly dividends from par value and stated rate
• [ ] Calculate conversion ratio from par value and conversion price
Rights and Warrants
• [ ] Understand that rights protect shareholders from dilution
• [ ] Know the rights-on formula (with +1) vs. the ex-rights formula
• [ ] Distinguish rights (short-term, below market) from warrants (long-term, above market at issuance)
• [ ] Calculate intrinsic value of a warrant
ADRs
• [ ] Know that ADRs trade in USD on U.S. exchanges but represent foreign company shares
• [ ] Understand that currency risk still exists even in USD-denominated ADRs
• [ ] Know the depositary bank's role in currency conversion and dividend distribution
• [ ] Distinguish sponsored vs. unsponsored ADRs
Dividends and Corporate Actions
• [ ] Memorize the four dividend dates in order: Declaration → Ex-Dividend → Record → Payment
• [ ] Know T+2 settlement means you must buy before the ex-date to receive the dividend
• [ ] Understand that stock dividends don't change total investment value
• [ ] Know why companies execute reverse stock splits (to raise share price for listing requirements)
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Good luck on the Series 7 exam! Focus on the formulas, the "who benefits" questions for callable/convertible securities, and the dividend date sequence — these are high-frequency exam topics.