Equity Securities

Section: Understanding Products and Their Risks — Equity Securities

Estimated study time: 45 minutes

Content:

Equity securities represent ownership in a corporation. The most common form is common stock. A common shareholder is a residual owner: in a liquidation, common stockholders are paid last, only after all creditors and preferred shareholders have been satisfied. In exchange for that junior position, common shareholders receive the greatest potential upside and the key ownership rights — the right to vote on major corporate matters (the board of directors, mergers, and stock splits), the right to receive dividends if and when declared by the board, the right to inspect corporate books, and a preemptive right (when granted) to maintain their proportional ownership by buying newly issued shares before the public. Common stock carries no maturity date and no guaranteed return, so its primary risk is market (price) risk.

Preferred stock is an equity security with debt-like features. It pays a fixed, stated dividend (expressed as a percentage of par, usually $100, or as a dollar amount) and has priority over common stock for both dividends and liquidation proceeds. Preferred shareholders normally do not vote. Because its value is driven largely by that fixed dividend, straight preferred stock behaves like a bond and carries interest-rate risk — its price falls when rates rise. Several variations exist: cumulative preferred accrues any skipped (passed) dividends, which must be paid in full before common shareholders receive anything; participating preferred can receive extra dividends beyond the stated rate; convertible preferred can be exchanged for a set number of common shares; and callable preferred can be redeemed by the issuer at a set price. On the SIE, cumulative preferred…