20 Equity Securities Practice Questions & Answers

1. 1. A 40-year-old client's primary objective is to grow purchasing power over a 25-year horizon. The adviser is comparing an issuer's common stock with the same issuer's fixed-rate preferred stock. Which statement best supports recommending the common stock?

   • A.Common stock is priced primarily off market interest rates, in much the same way a long-term bond is.
   • B.Common stock ranks ahead of the issuer's preferred stock when the corporation's assets are liquidated.
   • C.Common stock is a residual ownership claim, so its value can grow as the issuer's earnings and dividends grow.✓ Answer
   • D.Common stock carries a stated dividend rate that the issuer must pay before making any other distribution.

   Common stock is a residual claim: its holders are paid last, but they participate without limit in the issuer's growth, which is why equity has historically been the better long-horizon hedge against inflation. The other choices describe preferred stock — it has the stated dividend rate, it is priced like a long-duration bond because that dividend is fixed, and it ranks ahead of (not behind) common stock in liquidation.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — types of equity securities: common and preferred stockReport a problem with this question

2. 2. An income-oriented client asks whether the 5% stated dividend on a corporation's preferred stock is as dependable as the interest on that same corporation's bonds. Which statement is accurate?

   • A.The preferred dividend must be paid ahead of bond interest in any year in which the corporation reports earnings.
   • B.The preferred dividend is a contractual obligation that ranks equally with the corporation's bond interest.
   • C.The preferred dividend is payable only when the board declares it, while bond interest is a legal debt.✓ Answer
   • D.The preferred dividend accrues automatically each quarter and may be enforced by suit if the issuer omits it.

   A dividend of any kind becomes payable only when the board of directors declares it, so omitting a preferred dividend is not a default and cannot be sued upon, whereas failing to pay bond interest is a breach of a debt obligation. A cumulative feature makes unpaid dividends accumulate as arrearages that must be cleared before any common dividend, but even then the arrearage is not enforceable as a debt — which is precisely why preferred income is less dependable than bond interest for a client who needs the cash flow.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — preferred stock; dividends are payable only when declared by the board of directorsReport a problem with this question

3. 3. A client seeking steady income is considering a callable preferred stock. Which statement about the call feature should the adviser make?

   • A.The call feature raises the market value of the shares because it shortens the expected holding period.
   • B.The call feature obligates the issuer to redeem a fixed portion of the issue each year on a set schedule.
   • C.The call feature benefits the holder, who may require the issuer to redeem the shares at par value at any time.
   • D.The call feature benefits the issuer and tends to cap the price appreciation of the shares when rates fall.✓ Answer

   The call is an option held by the issuer, not the investor, and it is rational to exercise when dividend rates have fallen and the issue can be refinanced more cheaply — exactly when the holder would otherwise enjoy a price gain. That is why the market price of a callable preferred compresses toward the call price as rates fall, and why the adviser must raise reinvestment risk: the client gets cash back precisely when comparable income is hardest to replace.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — preferred stock, including callable preferredReport a problem with this question

4. 4. Why does a convertible preferred stock generally carry a lower stated dividend rate than otherwise comparable straight preferred stock of the same issuer?

   • A.Investors accept a lower dividend in return for the right to convert the shares into common stock.✓ Answer
   • B.Investors are protected by a regulatory cap on the dividend rate of any convertible preferred issue.
   • C.Investors give up the preferred liquidation preference and rank behind common stock in a wind-up.
   • D.Investors receive a conversion price that must be set below the common stock's market price at issue.

   The conversion privilege is an equity kicker: it lets the holder trade a fixed-income-like instrument for common shares if the common appreciates, and investors pay for that upside by accepting a lower stated dividend. A convertible preferred keeps its seniority over common stock, the conversion price is normally set above the common's market price at issue, and no regulator sets dividend rates on corporate securities.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — convertible preferred stockReport a problem with this question

5. 5. A client holds an unsponsored American Depositary Receipt and asks why she never receives the foreign issuer's proxy materials. Which explanation is accurate?

   • A.Holders of any ADR vote only through the depositary's board and never receive materials from the foreign issuer.
   • B.The depositary created the program without an agreement with the issuer, so votes and communications are generally not passed through.✓ Answer
   • C.The foreign issuer sponsored the program but is barred by U.S. law from soliciting proxies from American holders.
   • D.The depositary withholds the issuer's materials until the holder pays the foreign withholding tax on the dividend.

   A sponsored ADR rests on a deposit agreement between the depositary bank and the foreign issuer, under which the issuer bears part of the cost and shareholder communications and voting instructions are passed through to U.S. holders; an unsponsored program is set up by a depositary on its own initiative, the holder bears the fees, and the depositary generally has no duty to forward issuer materials or votes. The adviser should add that paying in U.S. dollars does not remove currency risk, because the dollar dividend is a translation of a foreign-currency payment net of foreign withholding tax.

   Source: SEC Investor Bulletin: American Depositary Receipts (sponsored and unsponsored programs)Report a problem with this question

6. 6. A client owning a small minority position asks which voting method would give her the best chance of helping elect one director. What should the adviser tell her?

   • A.Cumulative voting, because her total votes may all be cast for one candidate rather than spread.✓ Answer
   • B.Statutory voting, because votes she does not use carry forward to the next annual election.
   • C.Statutory voting, because each share casts one vote per open seat in every contested election.
   • D.Cumulative voting, because minority holders are allotted extra votes for each contested seat.

   Both methods give a shareholder the same total number of votes — shares multiplied by the number of seats being filled — so cumulative voting does not hand minority holders extra votes; what it changes is that those votes may be concentrated on a single candidate instead of being allocated one candidate at a time. That concentration is what gives a minority position a realistic chance of electing one director, whereas statutory voting lets a majority holder elect the entire board, and unused votes never carry forward to a later election.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — shareholder rights: statutory and cumulative votingReport a problem with this question

7. 7. A corporation plans to sell additional common shares and first offers its existing common shareholders the opportunity to subscribe in proportion to their holdings. What does this feature accomplish for the adviser's client?

   • A.It gives preferred shareholders the first claim on the new shares because of their liquidation preference.
   • B.It entitles the client to buy shares at a fixed price above the market for several years after issuance.
   • C.It obligates the corporation to repurchase the shares of any holder who declines to subscribe to the new issue.
   • D.It lets the client maintain her percentage ownership by subscribing at a price below the current market.✓ Answer

   The preemptive, or antidilution, right belongs to common shareholders and is exercised through a rights offering: each holder receives rights pro rata and may subscribe at a price set below the current market so that her proportionate ownership and voting power need not shrink. Preferred stock ordinarily carries no preemptive right, the corporation has no obligation to buy back the shares of a holder who does not subscribe, and a long-lived right to buy above the market price describes a warrant instead.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — shareholder rights: preemptive and antidilution rightsReport a problem with this question

8. 8. A client wants to buy a stock in time to receive a cash dividend the board has just declared. Under the current regular-way settlement cycle for U.S. equities, which statement is accurate?

   • A.The client may buy at any time before the payable date, because entitlement is fixed when the cash is distributed.
   • B.The client must buy before the declaration date, because the board fixes the list of entitled holders on that date.
   • C.The client must buy before the ex-dividend date, which now falls on the record date itself.✓ Answer
   • D.The client may buy on the ex-dividend date and still receive the dividend, because the ex-date follows the record date.

   The dividend sequence runs declaration date, then ex-dividend and record date, then payable date, and only a buyer whose trade settles on or before the record date appears on the books as a holder of record. Because standard settlement for U.S. equities shortened to T+1 on May 28, 2024, the ex-dividend date and the record date now fall on the same business day, so a trade made on the ex-date settles too late; older material teaching that the ex-date comes two business days before the record date describes the superseded convention.

   Source: SEC Rule 15c6-1 (T+1 standard settlement cycle, effective May 28, 2024)Report a problem with this question

9. 9. A client holds a domestic common stock in a taxable account for several years and receives cash dividends each quarter. Which statement describes the federal income tax treatment of those dividends?

   • A.Cash dividends are excluded from taxable income entirely once the shares have been held more than one year.
   • B.Cash dividends are taxed at the client's ordinary income rate no matter how long the shares have been held.
   • C.Cash dividends reduce the shareholder's cost basis in the shares rather than creating currently taxable income.
   • D.Cash dividends that meet the qualified-dividend holding-period test are taxed at long-term capital gains rates.✓ Answer

   A dividend paid by a U.S. corporation (or a qualified foreign corporation) is a qualified dividend when the shareholder satisfies the required holding period around the ex-dividend date, and qualified dividends are taxed at the preferential long-term capital gains rates rather than ordinary rates. Dividends that fail the test are taxed as ordinary income; in neither case is a cash dividend tax-free or a return of capital, so the shareholder's cost basis is unchanged — which matters when an adviser compares after-tax income across holdings.

   Source: Internal Revenue Code Section 1(h)(11); IRS Topic No. 404, DividendsReport a problem with this question

10. 10. An officer of an SEC-reporting company wants to sell shares of her employer that she bought in the open market. Which statement describes how Rule 144 applies to those sales?

    • A.Her sales are limited to 10% of the outstanding shares of that class each year, and the volume tests apply only to restricted stock.
    • B.Her sales in any three-month period are limited to the greater of 1% of the outstanding shares of that class or the average weekly reported volume of the preceding four weeks.✓ Answer
    • C.She is prohibited from selling any shares while she remains an officer, and the volume tests apply only after she resigns.
    • D.She may sell without limit after a six-month holding period, because the shares were bought in the market rather than privately.

    Shares held by an affiliate are control stock no matter how they were acquired, so buying them in the open market removes the holding-period problem but not the affiliate conditions: a volume cap measured over each three-month period, current public information about the issuer, ordinary brokers' transactions, and a Form 144 notice once the sale exceeds the rule's small de minimis amounts. A non-affiliate holding restricted stock is treated far more leniently, selling freely once the applicable holding period — six months for a reporting issuer, one year otherwise — has run.

    Source: SEC Rule 144 under the Securities Act of 1933 (volume limitations applicable to affiliates)Report a problem with this question

11. 11. A client exercises incentive stock options granted by her employer and holds the shares. What is the federal tax consequence at exercise?

    • A.No regular income tax is due at exercise, but the bargain element is an alternative minimum tax preference.✓ Answer
    • B.The bargain element is reported as a long-term capital gain at exercise because the option was granted earlier.
    • C.The bargain element is ordinary compensation income at exercise and is subject to payroll taxes.
    • D.No tax of any kind ever arises, provided the client holds the shares until the option would have expired.

    An incentive stock option produces no regular taxable income at grant or at exercise, but the spread between market value and exercise price on the exercise date is a preference item that can trigger alternative minimum tax — the planning point an adviser must raise before a large exercise. If the client then satisfies a qualifying disposition, holding the shares more than two years from grant and more than one year from exercise, the entire gain is long-term capital gain; selling earlier is a disqualifying disposition that converts the bargain element into ordinary compensation income.

    Source: Internal Revenue Code Section 422; IRS Topic No. 427, Stock OptionsReport a problem with this question

12. 12. A client exercises nonqualified stock options and keeps the shares. Which statement describes the federal tax result?

    • A.The spread creates no regular taxable income and is only an alternative minimum tax preference item at exercise.
    • B.The spread is deferred until the shares are sold, when the entire gain is reported as long-term capital gain.
    • C.The spread between market value and exercise price is ordinary income, and market value becomes the new basis.✓ Answer
    • D.The exercise price remains the basis, so the full gain at sale is reported as ordinary compensation income.

    Exercising a nonqualified option is a compensation event: the bargain element is wage income reported on the employee's Form W-2 and is subject to employment taxes in the year of exercise, and the market value used to measure it becomes the shareholder's cost basis. Any later appreciation is therefore capital gain, long-term or short-term depending on how long the shares are held after exercise, which is the opposite of the incentive stock option pattern in which no regular income arises at exercise.

    Source: IRS Topic No. 427, Stock Options; IRS Publication 525 (nonstatutory stock options)Report a problem with this question

13. 13. A stock is expected to pay a level annual dividend of $2.00 indefinitely, and the client's required rate of return is 5%. Using the zero-growth dividend discount model, what is the value of one share?

    • A.$40.00✓ Answer
    • B.$20.00
    • C.$100.00
    • D.$10.00

    The zero-growth form of the dividend discount model treats a level dividend as a perpetuity, so value equals the dividend divided by the required return: $2.00 / 0.05 = $40.00. The common errors are multiplying the dividend by the rate expressed as a whole number, or dividing by the wrong rate; note also that raising the required return lowers the computed value, which is why a client demanding more compensation for risk will find fewer stocks attractive.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — dividend discount modelReport a problem with this question

14. 14. An adviser uses the constant-growth dividend discount model to value a common stock. Which limitation should the adviser keep in mind?

    • A.The model disregards the investor's required rate of return and relies only on the company's past dividend record.
    • B.The model assumes the dividend declines each year, so it understates the value of a mature, profitable company.
    • C.The model is unusable for a company that pays no dividend and breaks down when growth approaches the required return.✓ Answer
    • D.The model cannot be applied when the required return is greater than the dividend growth rate, because the calculated value turns negative.

    The constant-growth model divides next year's dividend by the required return minus the growth rate, so it requires a dividend to exist and requires the required return to exceed growth; as growth approaches the required return the denominator shrinks toward zero and the value explodes, and if growth equals or exceeds it the result is meaningless. That is why a non-dividend-paying growth company is normally valued with discounted cash flow or an earnings-based method instead.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — dividend discount model, constant-growth formReport a problem with this question

15. 15. A client asks the adviser what a technical analyst is actually doing when studying a stock. Which description is accurate?

    • A.A technical analyst studies price and volume history, including support and resistance, to time purchases and sales.✓ Answer
    • B.A technical analyst examines the issuer's financial statements and industry position to estimate intrinsic value per share.
    • C.A technical analyst measures the portfolio's systematic risk against a benchmark index to select securities.
    • D.A technical analyst discounts projected future cash flows at a required rate to identify undervalued shares.

    Technical analysis works only with market-generated data — price, volume, trendlines, support and resistance, moving averages and sentiment indicators — on the assumption that patterns repeat, and its output is a judgment about timing rather than an estimate of what the business is worth. Fundamental analysis, including discounted cash flow, is what produces an intrinsic value, and beta measures a portfolio's systematic risk, which is a risk-management statistic rather than a valuation method.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — technical analysis and fundamental analysisReport a problem with this question

16. 16. Under the weak form of the efficient market hypothesis, what conclusion follows for a client who wants to trade on chart patterns of past prices?

    • A.Even nonpublic information is reflected in prices, so neither charting nor fundamental analysis can add excess return.
    • B.Past prices are already reflected in current prices, so charting past price patterns cannot produce consistent excess returns for the client.✓ Answer
    • C.Past prices are not yet reflected in current prices, so charting remains the most reliable way to earn excess returns.
    • D.Public financial statements are already reflected in prices, so only chart-based strategies can still add excess return.

    Weak-form efficiency states that all historical price and volume information is already impounded in the current price, so a strategy built entirely on that information has no informational edge left to exploit. Technical analysis rests on the opposite premise, which is why it is inconsistent with even the weakest form of the hypothesis; the semi-strong form adds all public information and undercuts fundamental analysis, and the strong form adds nonpublic information as well.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — efficient market hypothesis and methods of valuing equity securitiesReport a problem with this question

17. 17. An adviser computes a company's book value per share to compare it with the market price of the common stock. Which calculation produces book value per share?

    • A.The market price of the common stock divided by earnings per share for the most recent four quarters.
    • B.Total assets divided by the combined number of common and preferred shares the company has outstanding.
    • C.Net income minus preferred dividends, divided by the weighted average number of common shares outstanding.
    • D.Assets minus liabilities, intangible assets and the preferred claim, divided by common shares outstanding.✓ Answer

    Book value per share measures the accounting value of the common stock's residual claim, so liabilities, intangible assets such as goodwill, and the preferred stockholders' prior claim are all subtracted before dividing by the common shares outstanding. Comparing market price with that figure gives the price-to-book ratio, a metric value-oriented managers use; the other choices describe the price-to-earnings ratio and earnings per share, which measure earnings rather than net assets.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023) — price-to-book ratio and book value per shareReport a problem with this question

18. 18. A client reviewing a preliminary prospectus for an IPO notes that the registration statement will be declared effective and asks whether that means the government has approved the offering. How should the adviser answer?

    • A.Effectiveness means the underwriters have guaranteed the offering price and the earnings forecasts contained in the prospectus.
    • B.Effectiveness means the state administrator has certified the accuracy and completeness of the issuer's financial statements.
    • C.Effectiveness means the SEC has reviewed the issuer's business and found the offering suitable for public investors.
    • D.Effectiveness means the disclosure requirements were met; no regulator approves the offering or passes on its merits.✓ Answer

    Registration is a disclosure regime, not a merit review: the federal securities law expressly provides that neither the fact of an effective registration statement nor anything in the act means the Commission has passed on the merits or the accuracy of the filing, and the Uniform Securities Act likewise makes it unlawful to represent state registration as approval or a recommendation. The adviser should add that a preliminary prospectus carries no final price and may be used only to gather indications of interest, so no sale may be made from it.

    Source: Securities Act of 1933, Section 23; Uniform Securities Act prohibition on representing registration as approval or recommendationReport a problem with this question

19. 19. A company's founders sell a large block of their already-outstanding shares to the public in a registered offering. What should the adviser tell a client about this offering?

    • A.The proceeds must be divided between the issuer and the selling shareholders under federal securities law.
    • B.The proceeds go to the selling shareholders, and the number of outstanding shares is unchanged.✓ Answer
    • C.The proceeds go to the issuer's treasury, and the shares are retired when the offering has been completed.
    • D.The proceeds go to the issuer as new capital, and the ownership percentage of existing holders is diluted.

    This is a secondary offering: existing security holders sell shares that already exist, so the money goes to them and the issuer receives nothing, share count is unchanged and no dilution occurs. In a primary offering the issuer sells newly created shares and receives the proceeds, which does dilute existing holders, and a deal combining newly issued shares with shares sold by insiders is a split offering — a distinction that matters because many investors wrongly treat any follow-on sale as a secondary offering.

    Source: Securities Act of 1933 (registered offerings by selling security holders); NASAA Series 65 Test Specifications (effective June 12, 2023) — equity public offeringsReport a problem with this question

20. 20. A client asks about buying units of a special purpose acquisition company that has not yet identified a target business. What should the adviser explain?

    • A.The units represent an interest in an operating business that the sponsor selected before the offering closed.
    • B.The offering proceeds are held in trust, investors may redeem before a merger, and the sponsor's stake dilutes public holders.✓ Answer
    • C.The sponsor guarantees a minimum return on the trust account, and shareholders approve each investment it makes.
    • D.The trust account is insured against loss by a federal agency, so the position carries no risk to principal.

    A SPAC is a blank-check shell with no operating business: the IPO money is placed in a trust while the sponsor searches for a target within a fixed window, commonly eighteen to twenty-four months, and public investors hold a right to redeem their shares rather than take part in the proposed merger. The economics that drive suitability are the sponsor's promote and the warrants, which dilute public shareholders, plus the fact that nothing is guaranteed or insured and the pre-deal investment is speculative, so it fits only a client with the risk tolerance and time horizon to bear it.

    Source: SEC Investor Bulletin on Special Purpose Acquisition Companies; NASAA Series 65 Test Specifications (effective June 12, 2023) — equity public offerings including SPACs, blind pools and blank check companiesReport a problem with this question

Practice questions written from the NASAA Series 65 Test Specifications and the Uniform Securities Act. Not affiliated with or endorsed by NASAA, FINRA or Prometric. Dollar thresholds, fee figures and contribution limits change; where one matters the question supplies it. Confirm current requirements with NASAA before testing. NASAA exam content outline →