Every security a company issues stands in a line for payment. Bondholders stand at the front, preferred holders in the middle and common holders at the back, where risk and upside are both greatest.
Common stock is ownership in a corporation. Own 1,000 of a company's 1,000,000 shares and you own 0.1% of it. That stake is a residual claim on earnings and assets. You get what is left after creditors, bondholders and preferred holders are paid.
The claim carries these rights and limits:
- Voting rights: You usually get one vote per share to elect the board of directors and approve major changes such as mergers.
- Dividends: You receive dividends only when the board declares them. A skipped common dividend is never owed later.
- Limited liability: Your loss is capped at what you paid. If the company fails owing money, creditors cannot reach your personal assets.
- Preemptive right: Where the charter grants one, you may buy new shares before outsiders, so your ownership percentage isn't diluted.
Common mistakes
- Flipping the exchange rate: At ¥150 per dollar, you divide. Multiplying ¥6,000 by 150 gives a nonsense $900,000 instead of $40.
- Testing conversion against par: Judge conversion against the convertible's market price, as in Example 2.
- Giving ADRs 10-K reporting: Form F-6 holds no company information. Level 2 and 3 issuers file Form 20-F, and a Level 1 issuer files no annual reports with the SEC.
Bottom line
- Common stock: residual claim, usually one vote per share, dividends only when declared, limited liability, greatest growth and risk; nonvoting or low-vote classes are still common.
- Growth and small-cap stocks suit growth investors, income stocks suit income investors, and blue chips and defensive stocks (utilities, staples, health care) suit conservative investors.
- Foreign stock adds currency, political and country, accounting and disclosure, and liquidity risk; foreign tax withheld may be claimed as an IRC 901 credit, but not inside an IRA.
- ADRs trade in dollars on U.S. exchanges or over the counter, carry a set ratio and depositary fees, can be exchanged for the shares and keep currency risk; ADR price = ratio × foreign price ÷ foreign currency per dollar.
Exam shortcut
In any ADR math, write down the quote direction first. Foreign currency per dollar means divide, and dollars per unit of foreign currency means multiply. For a convertible, compute the ratio, conversion value and straight value before reading the choices. The higher value sets the price, and you judge conversion against market price, never par.
The full lesson (about 3,655 words, 24 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- B8
Browse all free Series 65 lessons or jump into free Series 65 practice questions.