Chapter 1: Equity Securities

Equity Security

A financial instrument that represents ownership in a corporation. Equity securities give investors a claim on the company’s assets and earnings, though these claims are subordinate to creditors. Common and preferred stock are the primary forms of equity securities.

Corporation

A legal business entity owned by shareholders that raises capital through the issuance of equity and debt securities. Shareholders benefit from limited liability, meaning they can only lose the amount invested.

Common Stock

An equity security representing ownership in a corporation that provides shareholders with voting rights, potential capital appreciation, and possible dividends. Dividends are not guaranteed, and common shareholders are last in priority in liquidation.

Book-Entry Form

A method of recording stock ownership electronically rather than issuing physical certificates. The broker-dealer maintains records of ownership on its books, increasing trading efficiency. Also referred to as street name registration.

Authorized Shares

The maximum number of shares a corporation is legally permitted to issue, as approved by the state of incorporation and specified in the corporate charter.

Issued Shares

Shares of authorized stock that have been sold by the corporation to the public.

Outstanding Shares

Issued shares that are currently held by investors. Outstanding shares are used to calculate earnings per share, voting power, and dividend distributions.

Treasury Stock

Shares that were previously issued and outstanding but were repurchased by the issuing company. Treasury shares are not considered outstanding and do not receive dividends or voting rights.

Par Value

A nominal value assigned to stock for legal purposes, often $1 or less for common stock. Par value is largely irrelevant to investors but sets a minimum issuance price in some states.

Limited Liability

A protection afforded to shareholders whereby they cannot lose more than the amount they invested in the corporation and are not personally responsible for corporate debts.

Voting Rights

Rights granted to common shareholders that allow them to elect the board of directors and vote on major corporate matters brought to a proxy vote.

Statutory Voting

A voting method in which shareholders may cast one vote per share for each open board seat, favoring majority shareholders.

Cumulative Voting

A voting method that allows shareholders to pool all votes and allocate them among board candidates as they choose, offering greater influence to minority shareholders.

Proxy

Authorization allowing a shareholder to vote without attending a meeting in person. Proxies may be submitted by mail or electronically and function as absentee ballots.

Proxy Statement

An SEC-required disclosure document sent to shareholders to solicit votes on board elections and major corporate actions, containing all material facts needed to vote.

Beneficial Owner

The investor who enjoys the economic benefits of ownership, including voting rights and dividends, even though the securities may be registered in another name.

Nominal Owner

The broker-dealer or financial institution in whose name securities are registered when held in street name.

Form 10-K

An annual audited financial report filed with the SEC that provides comprehensive information about a company’s financial condition and operations.

Liquidation Priority

The order in which claimholders are paid if a company liquidates, with creditors paid first, followed by preferred stockholders, and common stockholders paid last.

Dividend

A distribution of corporate profits to shareholders that must be declared by the board of directors and may be paid in cash or stock.

Capital Gain

A profit realized when a security is sold for more than its purchase price. Capital gains are taxable only when realized.

Unrealized Capital Gain (Paper Gain)

An increase in the value of a security that has not yet been sold and is therefore not taxed.

Pre-Emptive Rights

Rights granted to existing shareholders allowing them to purchase newly issued shares proportionally to maintain their ownership percentage and prevent dilution.

Subscription Rights (Rights)

Short-term instruments that allow shareholders to purchase additional shares at a price below market value. Rights may trade separately and are designed to preserve ownership percentages.

Ex-Rights

A condition in which stock trades without the attached rights, resulting in a lower market price than stock trading with rights attached.

Warrant

A long-term security that gives the holder the right to purchase a company’s common stock at a fixed price for an extended period, usually issued with another security as an incentive.

Exercise (Strike) Price

The predetermined price at which a warrant or right allows the holder to purchase the underlying stock.

Blue-Chip Stock

Stock of a large, financially stable company with a long history of steady earnings and dividends, offering modest growth and reliable income.

Income Stock

A stock that provides consistent dividend income, typically issued by mature companies with stable cash flows.

Cyclical Stock

A stock whose performance closely follows economic cycles, rising during economic expansion and falling during contractions.

Defensive Stock

A stock that tends to remain stable during economic downturns because it provides essential goods or services.

Growth Stock

A stock issued by a company that reinvests earnings for expansion rather than paying dividends, offering higher growth potential but increased risk.

Penny Stock

An unlisted equity security trading for less than $5 per share, typically in the OTC market, characterized by low liquidity, high volatility, and elevated risk.

Systematic Risk (Market Risk)

Risk that affects the entire market or broad segments of it and cannot be eliminated through diversification.

Beta

A measurement of a stock’s volatility relative to the overall market. A beta greater than 1 indicates higher volatility, while a beta less than 1 indicates lower volatility.

Non-Systematic Risk (Business Risk)

Company-specific risk that affects an individual security and can be reduced through diversification.

American Depositary Receipt (ADR)

A U.S.-traded security representing ownership in shares of a foreign company, denominated in U.S. dollars and paying dividends in U.S. currency.

American Depositary Share (ADS)

The actual shares of a foreign corporation represented by an ADR.

Political Risk

The risk that political instability or government actions in a foreign country will negatively impact an investment.

Currency Risk

The risk that fluctuations in foreign exchange rates will affect the value of an investment or its dividends.

Inflationary Risk

The risk that inflation in a foreign country will erode currency value and investment returns.

Preferred Stock

An equity security with characteristics of both stocks and bonds that pays fixed dividends and has priority over common stock in liquidation but usually lacks voting rights.

Cumulative Preferred Stock

Preferred stock that entitles shareholders to receive missed dividends in arrears before common stockholders receive dividends.

Straight (Non-Cumulative) Preferred Stock

Preferred stock that does not provide for payment of missed dividends.

Participating Preferred Stock

Preferred stock that allows shareholders to receive additional dividends under specified conditions.

Convertible Preferred Stock

Preferred stock that can be exchanged for common stock at a predetermined ratio, offering potential upside participation.

Callable Preferred Stock

Preferred stock that can be redeemed by the issuing company at its discretion, typically offering higher dividends due to call risk.

Adjustable-Rate Preferred Stock

Preferred stock whose dividend rate fluctuates based on a benchmark interest rate, resulting in greater price stability.

Negotiable Security

A security that can be freely transferred, assigned, or sold to another party.

Registrar

The entity responsible for ensuring that a company does not issue more shares than authorized and maintaining accurate ownership records.

Transfer Agent

The entity that records changes in ownership, issues new certificates, and handles stock splits and dividends.

Stock Endorsement

The act of signing a physical stock certificate to transfer ownership to another party.

Declaration Date

The date on which a company’s board of directors announces a dividend and specifies the record and payable dates.

Record Date

The date on which an investor must be listed as a shareholder on the company’s books to receive a dividend.

Payable Date

The date on which the dividend is actually distributed to shareholders.

Ex-Dividend Date

The first trading day on which a buyer of stock is not entitled to receive the declared dividend.

Cash Dividend

A dividend paid directly to shareholders in cash and taxable upon receipt.

Stock Dividend

A dividend paid in additional shares of stock, not taxable until the shares are sold.

Forward Stock Split

A split that increases the number of shares outstanding while proportionally reducing the share price, leaving total value unchanged.

Reverse Stock Split

A split that reduces the number of shares outstanding while increasing the share price, often used to meet exchange listing requirements.

Short Sale

A transaction in which an investor sells borrowed shares with the expectation of repurchasing them at a lower price to profit from a decline.

Buy to Cover

The act of purchasing shares to close out a short position.

Unlimited Risk

The risk associated with short selling whereby potential losses are unlimited because a stock’s price can rise indefinitely.