Equity Securities

Section 2.1: Equity Securities — Common and Preferred Stock Estimated study time: 60 minutes Content: Equity securities represent ownership interests in a corporation. Because Products and Their Risks constitutes 44% of the SIE exam — the single largest section — a thorough understanding of equity securities is essential. Common stock is the most basic form of corporate ownership. Common shareholders receive voting rights (typically one vote per share on matters like board elections and major corporate actions), the right to receive dividends if declared by the board, and a residual claim on assets in the event of liquidation — but only after all creditors and preferred stockholders have been paid. Because common shareholders are last in line in a bankruptcy, common stock carries the highest risk among a company's capital structure. It also carries the highest potential return: common shareholders benefit from unlimited price appreciation and have no ceiling on dividend growth. Preferred stock is a hybrid security that combines characteristics of both equity and debt. Preferred shareholders receive a fixed dividend that must be paid before any dividends are paid to common stockholders. In liquidation, preferred shareholders rank ahead of common shareholders but behind all creditors (bondholders). Most preferred stock is non-voting under normal circumstances. Preferred stock is generally more stable in price than common stock because of its fixed income component, but it does not participate in the company's growth the way common stock does. Several variations of preferred stock appear on the SIE exam. Cumulative preferred requires that any unpaid dividends accumulate as "dividends in arrears" and must be paid in full before common shareholders receive any dividends. Convertible preferred gives the holder the option to…