Exam Tips and Tricks
You will need to know at least one example of "other" securities for the exam.
American Depository Receipts (ADRs)
Foreign corporations may choose to "list" their shares on U.S. stock exchanges by issuing American Depository Receipts. This allows American investors to purchase the companies' shares without the companies having to register with the SEC. Typically, a large U.S. bank with offices in the foreign country will purchase a large quantity of the stock, hold it in trust and then issue the ADRs, which are backed by the shares held in trust. ADR purchases receive no voting rights. Dividends are declared in the foreign currency, but converted and paid in U.S. dollars.
Watch for "incorrect" answers to ADR questions, for example that dividends are paid in the foreign currency, that ADR holders have voting rights like holders of any other stock and that shares are held in trust at a foreign bank.
Also known as subscription rights, these privileges grant to existing shareholders the right to subscribe to shares of a new offering of common stock before they are offered to the public and at a lower subscription price than the market.
Because a corporation issues rights to raise additional funds quickly, these rights usually have a short life - a maximum duration of 45 days - during which they may be exercised, and they are freely transferable in the secondary market. That is, they may be traded like stocks on an exchange.
While in most cases, the offer ratio is 1-to-1 (that is, one share per subscription right), companies may offer rights according to a different subscription ratio.
- Rights that are not exercised or sold will expire at the end of the offer period, at which time the corporation will seek other financing options.
Warrants are like stock rights in that they offer the option to buy common stock in the future, at a specific subscription price. However, unlike rights, warrants usually do not expire for three to five years. In fact, many warrants have no expiry dates. Moreover, as you saw above, the subscription price for a rights offering is usually less than the stock's market price. Warrant subscription prices, on the other hand, are always higher than the current market price for the newly issued stock. Warrants are also traded on the open market.
Options are contracts to buy or sell a certain number of shares of an underlying stock (usually in round lots of 100) at a specified price over a given period of time. The party who buys the option, the buyer or holder, pays for the right to exercise the terms of the contract. The other party grants the owner the rights that may be exercised and is called the writer or seller of the option.
There are two types of options: calls and puts. The holder of a call option buys the right from the writer to buy an underlying security - or "call" the security away from the seller - at a fixed price. The writer of the call option in turn has an obligation to sell the security at that fixed price if the buyer exercises the right to call the stock away from the seller. When an investor owns a put, he has the right to sell, or put, the underlying security to the writer at a fixed price. The writer in turn has an obligation to buy the security from the put owner.
If the topic of options has you confused, see our Options Basics tutorial for a basic run through on options, and how they work, and why they are used.
Keep in mind that a right has a much shorter exercise period than a warrant and is offered at a lower market price than the stock. The opposite is true for warrants.
- Exchange Traded Funds (ETFs): ETFs are a type of security which combine features of both stocks and mutual funds. Each ETF is designed to track an index and owns a number of stocks. The portfolio is not actively managed and the ETF is traded like a stock. Therefore, the price of the ETF fluctuates throughout the day based on market demand.
- Hedge funds: Hedge funds are aggressive portfolios designed to both maximize returns while minimizing risks. They are available only to large sophisticated investors and are therefore unregulated.
InvestingMany companies choose to issue rights or warrants as an alternative means of generating capital to avoid dilution of existing share value.
InvestingWarrants and call options are securities that are quite similar in many respects, but they also have some notable differences. Both give the holder the right, but not the obligation, to buy a ...
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