Understanding Corporate Securities On The Series 62 Exam
Corporate Securities Limited Representative

One of the keys to passing the series 62 exam is to make sure that you have a complete understanding of how corporate securities will be tested on the Series 62 Exam. This article which was produced from material contained in our series 62 textbook and will help you master the material so that you pass the series 62 exam.


Warrants

A warrant is a security that gives the holder the opportunity to purchase common stock. Like a right, the warrant has a subscription price. However the subscription price on a warrant is always above the current market value of the common stock when the warrant is originally issued. A warrant has a much longer life than a right and the holder of a warrant may have up to ten years to purchase the stock at the subscription price. The long life is what makes the warrant valuable, even though the subscription price is higher than the market price of the common stock when the warrant is issued.

How Do People Get Warrants?

Units

Many times, companies will issue warrants to people who have purchased their common stock when it was originally sold to the public during its initial public offering (IPO). A common share that comes with a warrant attached to purchase an additional common share is known as a unit.

Attached to Bonds

Many times, companies will attach warrants to their bond offerings as a “sweetener” to help market the bond offering. The warrant to purchase the common stock makes the bond more attractive to the investor and may allow the company to issue the bonds with a lower coupon rate.

Secondary Market

Warrants will often trade in the secondary market just like the common stock. An investor who wishes to participate in the potential price appreciation of the common stock may elect to purchase the corporation’s warrant instead of its common shares.

Possible Outcomes of a Warrant

A warrant, like a right, may be exercised or sold by the investor. A warrant may also expire if the stock price is below the warrant’s subscription price at its expiration.

Rights vs. Warrants

Rights Warrants
Up to 45 days Terms Up to 10 years
Below the Market Subscription Price Above the market
May trade with or
Without common
Stock
Trading May trade with or
without common stock
or bonds
Issued to existing
Shareholders to
Ensure preemptive rights
Who Offered as a sweetener
to make securities more
attractive

American Depository Receipts (ADR’s) / American Depository Shares (ADS’s)

American Depository Receipts facilitate the trading of foreign securities in the US markets. An ADR is a receipt that represents the ownership of the foreign shares that are being held abroad in a branch of a United States bank. Each ADR represents ownership of between one to ten shares of the foreign stock and the holder of the ADR may request the delivery of the foreign shares. Holders of ADR’s also have the right to vote and the right to receive dividends that the foreign corporation declares for payment to share-holders.

Currency Risks

The owner of an ADR has currency risk along with the normal risks associated with the ownership of the stock. Should the currency of the country decline relative to the US dollar, the holder of the ADR will receive less US dollars when a dividend is paid and less in US dollars when the security is sold. It’s important to note that the dividend on the ADR is paid by the corporation, to the custodian bank, in the foreign currency. The custodian bank will convert the dividend to US dollars for distribution to the holders of the ADRs.

Functions of The Custodian Bank Issuing ADRs

ADRs are actually issued and guaranteed by the bank that holds the foreign securities on deposit. The custodian bank is the registered owner of the foreign shares and must guarantee that the foreign shares remain in the bank as long as the ADRs remain outstanding. Foreign corporations will often use ADRs as a way of generating US interest in their company. The issuance of the ADR allows them to avoid the long and costly registration process for their securities.

Real Estate Investment Trusts / REITs

A real estate investment trust or a REIT is a special type of equity security. REITs are organized for the specific purpose of buying, developing, or managing a portfolio of real estate. REITs are organized as a corporation or as a trust and publicly traded REIT’s will trade on the exchanges or in the over-the-counter market just like other stocks. A real estate investment trust is organized as a conduit for the investment income generated by the portfolio of real estate. REITs are entitled to special tax treatment under internal revenue code subchapter M. A REIT will not pay taxes at the corporate level so long as:

  • It receives 75% of its income from real estate
  • It distributes at least 90% of its taxable income to shareholders

So long as the REIT meet the above requirements, the income will be allowed to flow through to the shareholders and will be taxed at their rate. Dividends received by REIT shareholders will continue to be taxed as ordinary income.

Exchange-Traded Funds / ETFs

An exchange-traded fund or ETF is an equity security that represents an ownership interest in a basket or portfolio of underlying securities. Many ETFs are designed to track the performance of an underlying index such as the S & P 500 or the Dow Jones Industrial Average. Both large and small investors use ETFs as a way to gain exposure to the performance of an index or an industry sector such as technology or energy. ETFs like traditional closed-end funds allow investors to buy and sell the securities in the open market at any time during the trading day. Most ETFs are passively managed and maintain a fixed portfolio of securities. As a result the expense ratios charged by these ETFs will be lower than the fees changed by the actively managed portfolios of traditional mutual funds or actively managed ETFs. Exchange-traded funds provide investors with tax efficiency, reduced transaction costs and diversification with in an industry, sector or geographic region. Not all ETFs will be suitable for all investors. The ETF’s portfolio and objectives must meet the individual’s investment objectives and risk tolerance.