Equity Securities

The whole unit on one sheet: common stock ownership and risk, foreign access through depositary receipts, and preferred stock's hybrid nature and conversion math.

Which One-Liners Win Points?

• Common stock typically carries one vote per share on board elections, mergers and acquisitions, and charter amendments.
• Common dividends are never guaranteed and are variable; the board decides, and common is always paid after preferred.
• Common stockholders are last in line at liquidation, so they bear the highest risk in bankruptcy.
• Unlimited upside, limited downside: a common share cannot fall below zero, so the maximum loss is the amount invested.
• American Depositary Receipts (ADRs) are negotiable certificates from a U.S. depositary bank that let U.S. investors hold foreign companies, trading on U.S. markets in U.S. dollars.
• Preferred stock pays a fixed dividend rate, if declared (stated as a percentage of par or a dollar amount, not a guarantee), has priority over common if declared, and generally does not vote.
• Convertible preferred always trades at the higher of its investment value (as straight preferred) or its conversion value (what the common shares would be worth today).
• Preferred is equity, not debt: no maturity, dividends are not deductible by the issuer, and a skipped dividend is not a default.

What Does Common Stock Give the Owner?

• Represents an equity (ownership) stake; percentage owned equals shares held over total shares outstanding.
• Dividends can be paid in cash, additional shares (stock dividends), or property.
• Liquidation order: secured creditors, then unsecured creditors and bondholders, then preferred stockholders, then common stockholders last.
• Higher risk than preferred or bonds, but historically higher long-term returns.
• Foreign stock adds currency risk, political risk, regulatory risk, and liquidity risk on top of ordinary equity risk.

What Makes Preferred Stock a Hybrid?

• Less price volatility than common, but fixed rate preferred is more sensitive to interest rate changes (it behaves like a bond here).
• Floating rate preferred is the tested contrast. Its dividend resets against a reference rate, so it is far less sensitive to rate moves. A question describing a preferred issue that holds its value while rates move is describing floating rate preferred, and the "preferred behaves like a bond" rule does not carry across to it.
• "Fixed" refers to the rate, not a guarantee: the board must still declare each dividend.
• Priority over common in liquidation, but still subordinate to all debt holders.
• Conversion ratio = common shares received per preferred share.
• Conversion price = par value of preferred divided by the conversion ratio.
• Conversion value (parity) = conversion ratio times the market price of the common stock.
• The dividends-received deduction (DRD) lets corporate investors deduct part of preferred dividends received: 50% under 20% ownership, 65% at 20% or more but less than 80%, 100% for affiliated-group members at 80% or more.

Which Numbers Matter Most?

Which Gotchas Trip Students Up?

• Common dividends are never guaranteed: even record profits do not force a payout; the board has full discretion.
• Common shareholders bear the most risk in liquidation, not the least; they are paid after every creditor and preferred holder.
• ADRs do not eliminate currency risk: the underlying shares are still in the foreign currency, so exchange rate moves affect the ADR's value and dividends.
• Preferred is equity, not debt, despite the fixed income, interest rate sensitivity, and priority over common; a missed preferred dividend is not a default the way a missed bond interest payment is.
• Preferred dividends are NOT deductible by the issuing corporation (unlike bond interest), but corporate investors receiving them may claim the dividends-received deduction: both sides matter, who pays versus who receives.
• Convertible preferred trades at the higher of investment value or conversion value: calculate both and pick the larger number.

One-Breath Recap

Common stock is direct ownership with typically one vote per share, variable dividends the board can cut or skip, and last place at liquidation, which makes it the highest-risk claim but gives unlimited upside against a downside capped at the amount invested; foreign exposure through American Depositary Receipts trades in dollars yet keeps currency risk. Preferred stock is the hybrid: a fixed dividend rate (still declared, not guaranteed), priority over common, usually no vote, and bond-like interest-rate sensitivity. Convertible preferred always trades at the higher of its investment value or its conversion value, so run both numbers. Preferred is equity, not debt, so its dividends are not deductible to the issuer, though corporate investors can claim the dividends-received deduction.

Need more than the recap? Read the full Equity Securities unit.