Overview
Equity securities represent ownership interests in corporations and are a core topic on the SIE Exam. This guide covers common and preferred stock characteristics, rights and warrants, ADRs, and essential corporate actions. Understanding how these instruments work — and how they differ from one another — is critical for exam success.
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Common Stock
Summary
Common stock represents the most basic form of corporate ownership. Common stockholders enjoy potential upside through price appreciation and dividends, but they bear the greatest risk and hold the lowest priority claim in liquidation.
Key Concepts
• Voting Rights: Typically one vote per share on corporate matters (e.g., electing the board of directors)
• Limited Liability: Maximum loss is limited to the total amount invested (cost basis); stockholders are not personally liable for corporate debts
• Residual Claim: In liquidation, common stockholders are paid last — after debt holders, general creditors, and preferred stockholders
• Preemptive Rights: Give existing shareholders the right to purchase newly issued shares before the public to maintain their proportional ownership percentage
Types of Voting
| Voting Method | How It Works | Who Benefits |
|---|---|---|
| Statutory Voting | One vote per share, per board candidate | Majority shareholders |
| Cumulative Voting | All votes can be concentrated on one candidate | Minority shareholders |
Stock Splits
| Action | Effect on Shares | Effect on Price | Effect on Total Value |
|---|---|---|---|
| Forward Stock Split | Increases | Decreases proportionally | Unchanged |
| Reverse Stock Split | Decreases | Increases proportionally | Unchanged |
> Example: A 2-for-1 stock split doubles the number of shares but halves the price per share. A shareholder with 100 shares at $50 now holds 200 shares at $25.
Key Terms
• Book Value Per Share – Net asset value (total assets minus total liabilities) divided by shares outstanding; represents the accounting value per share
• Authorized Shares – Maximum shares a company may issue per its corporate charter
• Issued Shares – Authorized shares that have actually been sold to investors
• Outstanding Shares – Issued shares minus treasury shares
• Treasury Stock – Shares the company has repurchased and holds (not outstanding)
Formula to Know
> Outstanding Shares = Issued Shares − Treasury Shares
⚠️ Watch Out For
• Common stockholders have residual rights — they get what's left over. Do not confuse "lowest priority" with "no rights at all."
• A stock split does not change total investment value — a popular trap question.
• Cumulative voting benefits minority shareholders (not majority) — this distinction is frequently tested.
• Preemptive rights are about maintaining proportional ownership, not about receiving dividends.
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Preferred Stock
Summary
Preferred stock is a hybrid security with characteristics of both equity and debt. It pays a fixed dividend and has priority over common stock in dividends and liquidation, but typically does not carry voting rights.
Types of Preferred Stock
#### Cumulative Preferred
• Unpaid dividends accumulate as "arrears"
• All accumulated arrears must be paid before common stockholders receive any dividend
• Provides the greatest dividend protection for investors
#### Non-Cumulative Preferred
• Passed (skipped) dividends are lost permanently
• No requirement to pay arrears before common dividends resume
#### Participating Preferred
• Receives the fixed dividend plus the potential to share in additional dividends paid to common stockholders
• Allows participation in excess corporate profits
#### Convertible Preferred
• Can be exchanged for a specified number of common shares at the holder's option
• Conversion ratio = number of common shares received per preferred share
• Generally offers lower dividend yield in exchange for conversion feature
#### Callable Preferred
• The issuing company has the right to redeem shares at a predetermined call price (typically at a premium to par) after a specified date
• Companies call preferred stock when interest rates decline (to reissue at lower rates)
• Disadvantageous to investors — creates reinvestment risk
#### Adjustable-Rate (Variable-Rate) Preferred
• Dividend rate fluctuates based on a benchmark (e.g., Treasury rates)
• Reduces interest rate risk compared to fixed-rate preferred
Interest Rate Relationship (Critical Concept)
> Interest rates ↑ → Fixed-rate preferred stock price ↓
> Interest rates ↓ → Fixed-rate preferred stock price ↑
This inverse relationship applies to all fixed-income-like instruments.
Liquidation Priority (High to Low)
1. Secured debt holders
2. Unsecured creditors / bondholders
3. Preferred stockholders
4. Common stockholders ← paid last
Key Terms
• Arrears – Accumulated unpaid dividends on cumulative preferred stock
• Conversion Ratio – Number of common shares received when converting one preferred share
• Call Price – Predetermined price at which the issuer may redeem callable preferred stock
• Par Value – The stated face value of preferred stock (typically $25 or $100); dividends are often expressed as a percentage of par
⚠️ Watch Out For
• Cumulative preferred protects investors; callable preferred protects the issuer. Know which benefits whom.
• Preferred stockholders generally do not have voting rights — this distinguishes them from common stockholders.
• When asked about liquidation order, remember: "Debt before equity, preferred before common."
• Adjustable-rate preferred reduces interest rate risk; fixed-rate preferred does not.
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Rights and Warrants
Summary
Rights and warrants are both equity-related privileges that allow the purchase of common stock at a specified price, but they differ significantly in time horizon, exercise price, and purpose.
Subscription Rights
• Short-term privilege (typically expire in 30–45 days)
• Given to existing shareholders to purchase new shares at a subscription price below current market price
• Purpose: Allow shareholders to maintain proportional ownership (similar to preemptive rights)
• Can be traded in the secondary market (holders may sell rather than exercise)
Warrants
• Long-term instruments (often valid for several years or even perpetually)
• Exercise (strike) price set above the current market price at issuance (out of the money initially)
• Commonly attached to bonds or preferred stock as a "sweetener" to make offerings more attractive
• Can be traded separately in the secondary market
Rights vs. Warrants Comparison
| Feature | Subscription Rights | Warrants |
|---|---|---|
| Duration | Short-term (30–45 days) | Long-term (years/perpetual) |
| Exercise Price vs. Market | Below market (in the money) | Above market (out of the money) |
| Issued To | Existing shareholders | Attached to bonds/preferred stock |
| Purpose | Maintain ownership % | Attract investors ("sweetener") |
| Tradeable? | Yes | Yes |
⚠️ Watch Out For
• Rights are issued below market price; warrants are issued above market price — this is a classic exam trick.
• Both can trade in the secondary market — holders are not required to exercise them.
• Warrants attached to bonds are used as a sweetener, not as a right for existing shareholders.
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American Depositary Receipts (ADRs)
Summary
ADRs allow U.S. investors to invest in foreign companies through a domestic, dollar-denominated instrument. They trade on U.S. exchanges and simplify international investing while introducing unique risks.
Key Features
• Issued by a U.S. bank (depositary bank) as negotiable certificates
• Represent shares of a foreign company's stock held in custody
• Allow U.S. investors to buy foreign stocks without dealing directly in foreign markets or currencies
• Dividends paid in U.S. dollars (foreign company pays in local currency; depositary bank converts)
• Sponsored ADRs can trade on major U.S. exchanges (NYSE, Nasdaq) or OTC, depending on sponsorship level and SEC registration
Unique Risk: Currency (Exchange Rate) Risk
> Changes in the foreign currency's value relative to the U.S. dollar can impact both dividend income and the ADR's market price.
• This risk does not apply to domestic stock investments
• If the foreign currency weakens relative to the USD, ADR value and dividends may decrease even if the foreign stock price is unchanged
Key Terms
• Depositary Bank – U.S. bank that issues the ADR and holds the underlying foreign shares
• Sponsored ADR – Issued with the cooperation of the foreign company; can be listed on major exchanges
• Unsponsored ADR – Created without the foreign company's involvement; typically trades OTC
• Currency Risk – The risk that exchange rate fluctuations will negatively affect investment returns
⚠️ Watch Out For
• ADR dividends are received in U.S. dollars, but the underlying dividend is paid in foreign currency — currency risk still applies.
• ADRs do not eliminate currency risk; they only simplify the mechanics of investing internationally.
• Sponsored ADRs have more regulatory oversight and are more likely to be listed on major exchanges.
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Equity Concepts & Corporate Actions
Summary
Understanding corporate actions — events that affect a company's shares or shareholder rights — is essential for the SIE Exam. These events impact share count, price, entitlements, and investor decisions.
Key Corporate Actions
#### Ex-Dividend Date
• The first date on which a buyer is NOT entitled to the declared dividend
• Buyers who purchase on or after the ex-dividend date do not receive the upcoming dividend
• The seller (who owned shares before the ex-date) receives the dividend
> Dividend Timeline: Declaration Date → Ex-Dividend Date → Record Date → Payment Date
#### Stock Buyback (Share Repurchase)
• Company repurchases its own outstanding shares from the market
• Repurchased shares become treasury stock
• Treasury stock is not outstanding and does not receive dividends or vote
• Buybacks reduce outstanding shares, which can increase earnings per share (EPS)
#### Share Classifications
| Term | Definition |
|---|---|
| Authorized Shares | Maximum shares permitted by corporate charter |
| Issued Shares | Authorized shares sold to investors |
| Treasury Shares | Issued shares repurchased by the company |
| Outstanding Shares | Issued shares − Treasury shares |
#### Stock Splits (Revisited)
• Forward Split (e.g., 2-for-1): More shares, lower price, same total value
• Reverse Split (e.g., 1-for-5): Fewer shares, higher price, same total value
- Companies use reverse splits to raise share price and meet exchange listing requirements
⚠️ Watch Out For
• Buying stock on the ex-dividend date means you do not get the dividend — "on or after" = no dividend.
• Treasury stock has no voting rights and receives no dividends — it is not "outstanding."
• A reverse stock split does not increase shareholder wealth; it only raises the per-share price.
• Authorized shares ≠ Issued shares ≠ Outstanding shares — know all three and how they relate.
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Quick Review Checklist
Use this checklist to confirm you can confidently answer questions on each topic:
Common Stock
• [ ] Common stockholders vote one vote per share (statutory) or concentrate votes (cumulative)
• [ ] Common stockholders have lowest priority in liquidation
• [ ] Maximum loss = amount invested (limited liability)
• [ ] Stock splits change share count and price but not total value
• [ ] Preemptive rights preserve proportional ownership
• [ ] Cumulative voting benefits minority shareholders
• [ ] Outstanding shares = Issued − Treasury
Preferred Stock
• [ ] Preferred stockholders paid before common, after creditors in liquidation
• [ ] Cumulative preferred accumulates unpaid dividends as arrears
• [ ] Callable preferred can be redeemed by the issuer
• [ ] Convertible preferred can be exchanged for common shares at holder's option
• [ ] Fixed-rate preferred price moves inversely with interest rates
• [ ] Adjustable-rate preferred reduces interest rate risk
Rights and Warrants
• [ ] Rights: short-term (30–45 days), priced below market
• [ ] Warrants: long-term (years), priced above market at issuance
• [ ] Both can trade in secondary market
• [ ] Warrants used as sweeteners for bonds/preferred stock
ADRs
• [ ] ADRs are issued by U.S. depositary banks for foreign stocks
• [ ] Dividends paid in U.S. dollars
• [ ] Currency risk is unique to ADRs vs. domestic stocks
• [ ] Sponsored ADRs can list on NYSE, Nasdaq, or OTC
Corporate Actions
• [ ] Ex-dividend date = first day buyer does NOT get dividend
• [ ] Treasury stock = repurchased shares; no votes, no dividends
• [ ] Reverse stock split raises price to meet listing requirements; does not change total value
• [ ] Know the difference: Authorized → Issued → Outstanding
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Focus extra attention on liquidation priority, the rights vs. warrants comparison, and the ex-dividend date rule — these are among the most frequently tested topics in this category.