Overview of Equity Securities

Equity Investments, LOS weight share 2.2 percent of the 365 Level I learning outcomes.

Equity InvestmentsOverview of Equity Securities

A callable preferred share and a putable preferred share sound like mirror images, and the exam bets a candidate will forget that the call option belongs to the issuer while the put option belongs to the investor, the single distinction that decides every question about either one.

Before you watch

Answer these three first. Getting them wrong now is normal, and it helps the lesson stick. Reveal the answers when you're done, then read on.

1. A company's cumulative preferred stock pays a $3.00 annual dividend and has skipped dividends for two consecutive years. Before any common dividend can be paid in year three, the minimum preferred dividend owed per share is:

Answer: B. Cumulative preferred requires every skipped dividend to be paid before any common dividend: two years in arrears ($3.00 x 2 = $6.00) plus the current year's $3.00 equals $9.00. Non-cumulative preferred, by contrast, would let the skipped years disappear permanently.

2. A callable preferred share was issued when interest rates were 6%. Rates later fall to 4%. The issuer will most likely:

Answer: B. The call option belongs to the issuer, and falling rates make refinancing attractive: the issuer redeems the higher-cost preferred at the call price and can issue new preferred at the now-lower rate, the same logic as refinancing a mortgage. This creates reinvestment risk for the investor, who now must reinvest the call proceeds at a lower rate.

3. Company A holds a sponsored Level I ADR structure for its foreign shares. This means the ADR:

Answer: B. A sponsored Level I ADR involves the foreign company's cooperation with the depositary bank but requires only minimal SEC reporting (Form F-6), and it trades over the counter, not on a major exchange. Full exchange listing requires Level II; raising new capital requires Level III. Unsponsored ADRs, by contrast, are created without any cooperation from the foreign company at all.

The lesson

The video lesson for this unit is recorded and waiting to be published. Everything it teaches is written out below.

The reading

Five to ten minutes on this one unit: what the exam wants, the idea in plain words, then straight into the trap and the practice.

The exam wants you to compare the characteristics of common and preferred shares, describe statutory and cumulative voting, describe the risk and return of different types of equity securities, compare public and private equity, and describe the methods for investing in non-domestic equity, including depositary receipts.

Common stock carries two things preferred stock ordinarily does not. One is a vote on governance matters. The other is the residual claim on the company's assets, whatever is left once every creditor and every preferred shareholder has been paid. That residual position makes common stock the riskiest layer of the capital structure. It is also the layer with unlimited upside, since nothing caps what is left over once every claim ahead of it is satisfied. Preferred stock trades that vote away for a priority claim instead: a fixed dividend that must be paid before any common dividend. For cumulative preferred, any dividend skipped in a prior year stacks up as an obligation. It must be cleared in full before a single dollar reaches common shareholders again.

Voting mechanics decide how much say a minority shareholder actually has. Under statutory voting, one vote per share per director seat, a majority bloc wins every contested seat outright. Under cumulative voting, a shareholder's total votes equal shares held multiplied by the number of seats being elected. Every one of those votes can be concentrated on a single candidate. That is the mechanism that lets a determined minority guarantee at least one board seat even without majority support.

A callable feature and a putable feature look like mirror images, and the exam tests them as opposites. A callable share gives the issuer the right to redeem it at a set price. The issuer exercises that right when rates fall and refinancing at a lower cost becomes attractive, leaving the investor with reinvestment risk. A putable share gives the investor the right to sell it back to the issuer at a set price instead, most valuable to the investor when rates rise and the shares would otherwise be worth less on the open market. Whichever side holds the option is the side the feature benefits.

Risk and expected return rank in a predictable order across the equity spectrum. A non-cumulative, non-participating, non-convertible, callable preferred share behaves most like a bond. It pays a fixed amount, does not participate in growth, and carries a call feature that caps its own upside, making it the lowest-risk, lowest-expected-return instrument on this list. Convertible or participating preferred adds genuine equity upside and sits between plain preferred and common. Common stock sits at the top of both risk and expected return, exactly where its residual claim and unlimited upside put it.

Public equity trades on an organized exchange with continuous price discovery and standardized disclosure. Private equity is held by a small number of investors, is far less liquid, carries lighter disclosure requirements, and is priced by negotiation rather than a quoted market. That is exactly why private equity investors demand a higher expected return, to compensate for the illiquidity. Depositary receipts are the most common route into non-domestic equity for a domestic investor. A depositary bank holds the underlying foreign shares and issues a certificate representing them, an ADR in the United States or a GDR listed across several non-domestic markets. A sponsored ADR involves the foreign company's cooperation and some ongoing disclosure. An unsponsored ADR is created by a bank without the company's involvement at all. Only a Level III sponsored ADR, carrying full registration, lets the foreign company actually raise new capital in the US public market. Levels I and II only facilitate secondary trading of shares that already exist.

The trap

Callable and putable are opposite options held by opposite parties: a callable feature benefits the issuer and creates reinvestment risk for the investor, while a putable feature benefits the investor directly, and confusing which side holds the option flips the entire answer on a features question.

Learning outcomes covered by this module

Verbatim from the 2026 CFA Level I topic outline. Every practice question and key rule below is tagged to one of these where the stem and explanation make the match clear.

  1. describe characteristics of types of equity securities
  2. describe differences in voting rights and other ownership characteristics among different equity classes
  3. compare and contrast public and private equity securities
  4. describe methods for investing in non-domestic equity securities
  5. compare the risk and return characteristics of different types of equity securities
  6. explain the role of equity securities in the financing of a company's assets
  7. contrast the market value and book value of equity securities
  8. compare a company's cost of equity, its (accounting) return on equity, and investors' required rates of return

Key rules

Written from this module's own lesson and the 2026 CFA Level I topic outline, in teaching order, each tagged to the learning outcome it belongs to where that is clear.

LOS 01

Common stock carries voting rights and a residual claim; preferred stock trades voting rights for a priority claim

Common shareholders vote on governance matters and hold the residual claim on assets, whatever remains after all creditors and preferred shareholders are paid, which makes common the riskiest layer of the capital structure but also the one with unlimited upside. Preferred shareholders ordinarily have no vote in exchange for a fixed dividend that must be paid before any common dividend, and a priority claim in liquidation that ranks above common but below every class of debt.

LOS 02

Statutory voting hands every seat to the majority; cumulative voting lets a minority concentrate its votes on one seat

Under statutory voting, one vote per share per director seat, a majority bloc wins every contested seat. Under cumulative voting, a shareholder's total votes equal shares held multiplied by the number of seats being elected, and all of them may be cast for a single candidate, which is the mechanism that lets a sufficiently large minority guarantee at least one board seat even without majority support.

LOS 01

A callable feature favors the issuer; a putable feature favors the investor

Callable preferred gives the issuer the right to redeem shares at a set price, most valuable to the issuer when rates fall and refinancing at a lower rate becomes attractive, which creates reinvestment risk for the holder. Putable preferred gives the holder the right to sell shares back to the issuer at a set price, most valuable to the investor when rates rise and the shares would otherwise trade below that price. Participating preferred lets holders share in profits above a stated threshold; convertible preferred lets holders exchange shares for common at a set ratio, both features that benefit the investor when the company performs well.

LOS 03

Private equity is illiquid, less regulated, and priced by negotiation rather than a continuous market

Public equity trades on an organized exchange or public market with continuous price discovery and standardized regulatory disclosure; private equity is held by a small number of investors, is far less liquid, carries lighter disclosure requirements, and is valued through negotiated transactions rather than a quoted market price, which is why private equity investors typically demand a higher expected return to compensate for illiquidity and reduced transparency.

LOS 04

Depositary receipts and global shares are the two main routes into non-domestic equities, and they work differently

A depositary receipt, an ADR in the United States or a GDR listed across multiple non-domestic markets, is a certificate issued by a depositary bank representing underlying foreign shares it holds; a sponsored ADR involves the foreign company's cooperation and carries some SEC disclosure, an unsponsored ADR is created by a bank without the company's involvement, and only Level III sponsored ADRs, with full SEC registration, let the foreign issuer raise new capital in US markets. A global registered share, by contrast, is the same underlying share of the company itself, tradeable natively and fungibly across multiple exchanges without a depositary intermediary.

LOS 05

Risk and return rank, from lowest to highest, roughly as non-convertible preferred, convertible preferred, then common

A non-cumulative, non-participating, non-convertible, callable preferred share behaves most like a bond: a fixed payment with no growth participation and a call feature capping upside, which is the lowest-risk, lowest-expected-return equity instrument. Convertible or participating preferred adds genuine equity upside and sits between plain preferred and common in risk and expected return. Common stock carries the highest risk and, on average, the highest expected return, since it is paid last in every scenario and has no cap on its upside.

LOS 06

Equity financing funds a company's assets without a fixed repayment obligation, unlike debt

Issuing equity raises capital the company never has to repay on a fixed schedule and carries no mandatory interest cost, unlike debt, but it dilutes existing owners' claim on future earnings and typically costs the company more in expected return than debt, since equity holders bear more risk and are paid last, and therefore require compensation for that risk.

LOS 07

Book value is an accounting figure; market value is what the market is willing to pay, and the two routinely diverge

Book value of equity is total assets minus total liabilities as recorded under accounting rules, largely a historical-cost figure; market value is share price times shares outstanding, reflecting the market's forward-looking expectations of future cash flows and risk. A company can trade well above book value when investors expect strong future growth, or below book value when the market doubts the sustainability of reported assets or earnings.

LOS 08

Cost of equity, return on equity, and an investor's required rate of return are three related but distinct figures

Cost of equity is the company's own estimate of what it must earn on equity-financed projects to satisfy investors, typically derived from a model like CAPM. Return on equity is a backward-looking accounting measure, net income divided by average equity, describing how the company actually performed. An individual investor's required rate of return is that investor's own minimum acceptable return given the stock's risk, which may differ from the company's modeled cost of equity depending on the investor's own assumptions and risk tolerance.

The trick

Authored only where a key rule has an arbitrary number, list, or formula shape worth a memory device; a module with none of those has no tricks here, on purpose.

Cumulative arrears must clear before any common dividend

Every skipped cumulative preferred dividend stacks up as a debt-like obligation to preferred holders that must be paid in full before a single dollar reaches common shareholders.

Callable = issuer's option. Putable = investor's option

Whichever side holds the embedded option benefits from it. Issuers call when rates fall; investors put when rates rise.

ADR levels: I trades OTC only, II lists on an exchange, III raises new capital

Only a Level III, fully SEC-registered ADR lets a foreign issuer sell new shares into the US public market; Levels I and II only facilitate secondary trading of existing shares.

The method

Authored, ordered steps for answering this module's question types; a calculation module's calculator-dependent step ends with a bracketed BA II Plus keystroke sequence.

  1. Identify whether the security is common or preferred, and if preferred, list which embedded features it carries: cumulative, participating, callable, putable, convertible.
  2. For a cumulative-dividend question, sum every year's arrears plus the current year before any common distribution can occur.
  3. For an option-feature question, ask who holds the option, the issuer or the investor, and reason from whose interest the exercise decision serves.
  4. For a non-domestic access question, determine whether the instrument is a depositary receipt (a claim on shares held by a bank) or a global registered share (the actual share itself, tradeable natively across markets).
  5. For a market-versus-book or cost-of-equity question, keep the three separate: book value is accounting history, market value is forward-looking price, cost of equity is a modeled minimum required return, and ROE is a realized accounting outcome.

One card

Condensed from the key rules and tricks above, nothing new. What you'd want on one index card the night before.

Practice questions

Pick an answer, say how sure you are, then reveal. Every wrong choice gets its own explanation. 10 question(s) available for this unit.

Question 1Exam level

An investor holds 1,000 shares of a company with 5 board director seats up for election. Under cumulative voting, the maximum number of votes the investor can cast for a single director candidate is closest to:

How sure are you?

Correct: A. Under cumulative voting, a shareholder receives votes equal to shares held multiplied by the number of director seats being contested. The shareholder may concentrate all votes on one candidate. 1,000 shares × 5 seats = 5,000 total votes, all of which may be cast for one director. Under statutory (straight) voting, the investor would cast a maximum of 1,000 votes per seat. Cumulative voting is designed to give minority shareholders greater board representation power. The exam tests this distinction frequently.
B. Choosing 200 might tempt you if you mistakenly divide the total votes by the number of seats, thinking each seat gets an equal share of your votes, but under cumulative voting, you can concentrate all your votes on a single candidate, making 200 far too conservative.
C. Choosing 5 might tempt you if you mistakenly think each share only gets one vote for each seat, but cumulative voting allows you to concentrate all your votes on a single candidate, so you multiply your shares by the number of seats, not limit yourself to one vote per seat.

Unit: overview-of-equity-securities

Question 2Exam level

A company's preferred stock pays a cumulative dividend of $3.00 per share annually. The company skipped dividends in Year 1 and Year 2 due to financial difficulty. In Year 3, the company earned sufficient profits to resume dividends. Before paying any common stock dividend in Year 3, the minimum total preferred dividend per share that must be paid is closest to:

How sure are you?

Correct: B. Cumulative preferred stock requires that all dividends in arrears (unpaid dividends from prior periods) must be paid before any common dividend can be distributed. Two years of arrears ($3.00 × 2 = $6.00) plus the current year's dividend ($3.00) = $9.00 total. Non-cumulative preferred stock does NOT accumulate arrears. Skipped dividends are gone permanently. This distinction is the single most tested concept in preferred stock on the CFA exam.
A. Choosing $6.00 might seem right if you only considered the dividends in arrears from Year 1 and Year 2, but it ignores the current year's dividend requirement for cumulative preferred stock, which means you must also add the Year 3 dividend of $3.00, making the total $9.00.
C. Choosing $0 because you might think preferred dividends are discretionary overlooks the mandatory nature of cumulative preferred dividends, which require all missed dividends plus the current year's dividend to be paid before any common dividends, totaling $9.00 in this case.

Unit: overview-of-equity-securities

Question 3Exam level

Which of the following best describes a sponsored Level I American Depositary Receipt (ADR)?

How sure are you?

Correct: B. Sponsored Level I ADRs are the most common. The foreign issuer cooperates with the depositary bank but is exempt from full SEC registration. They need only file Form F-6 and provide materials translated into English. They trade OTC (Pink Sheets/OTC Bulletin Board), NOT on major exchanges. Level II ADRs trade on major exchanges (NYSE, NASDAQ, AMEX) and require full Form 20-F filing. Level III ADRs additionally allow new capital raising in the US public markets. Unsponsored ADRs are created by depositary banks WITHOUT the foreign company's involvement and always trade OTC.
A. You might be tempted by choice A if you confuse sponsored with unsponsored ADRs, but choice A describes an unsponsored ADR where the foreign company does not cooperate, whereas in a sponsored Level I ADR, the foreign company actively cooperates with the US depositary bank.
C. You might be tempted by choice C if you associate SEC registration with the ability to raise new capital, but remember that sponsored Level I ADRs only meet minimal SEC reporting requirements and do not allow for new capital raising in the US primary market like Level III ADRs do.

Unit: overview-of-equity-securities

Question 4Exam level

Participating preferred stock is MOST likely to benefit shareholders when:

How sure are you?

Correct: B. Participating preferred stock allows holders to receive additional dividends beyond the stated rate if the company's profits exceed a specified threshold. Effectively 'participating' in the company's success alongside common shareholders. This feature benefits holders only when the company is highly profitable and declares excess dividends. The other scenarios describe benefits of cumulative preferred (A), liquidation preference (B), and falling interest rates which benefit non-callable fixed-rate preferred (D).
A. You might be tempted by choice A because it aligns with the typical liquidation preference of preferred stock, but participating preferred stock specifically benefits from additional dividends when the company is profitable, not from recovering par value during liquidation.
C. You might be tempted by choice C because falling interest rates typically make fixed-income securities more attractive, but participating preferred stock benefits from company profitability, not interest rate movements, making this choice irrelevant to the question.

Unit: overview-of-equity-securities

Question 5Exam level

Putable preferred stock is MOST advantageous to investors when:

How sure are you?

Correct: A. Putable preferred stock gives the holder the right to sell shares back to the issuer at a predetermined price. This right is most valuable when interest rates rise, because rising rates reduce the market value of fixed-income-like instruments (including fixed-rate preferred stock). The put option allows investors to exit at the put price rather than selling at a depressed market price. Callable preferred benefits the ISSUER when rates fall (they can refinance at lower cost). Convertible preferred benefits investors when the common stock price rises.
B. You might be tempted by the idea that a premium call is beneficial because it offers extra money, but remember that a put option is most valuable when market conditions, like rising interest rates, make the stock less valuable; a premium call by the company does not leverage this put feature effectively.
C. You might be tempted by the conversion feature of preferred stock, thinking it offers flexibility, but convertible preferred stock is designed to benefit from rising common stock prices, not to protect against rising interest rates like a put option does.

Unit: overview-of-equity-securities

Question 6Exam level

Global Depositary Receipts (GDRs) most likely differ from American Depositary Receipts (ADRs) primarily because GDRs:

How sure are you?

Correct: B. GDRs are negotiable certificates representing ownership of shares in a foreign company, similar to ADRs, but they can be listed and traded on multiple exchanges in multiple countries simultaneously (e.g., London Stock Exchange, Luxembourg Stock Exchange, Dubai Financial Market). ADRs are specifically structured for US markets and denominated in USD. GDRs are typically denominated in USD or Euros and are commonly used by companies seeking capital from investors across multiple jurisdictions without listing in each country's domestic market.
A. You might think GDRs bypass the need for a depositary bank, but both GDRs and ADRs require a depositary bank to act as an intermediary, making choice A incorrect.
C. You might think that GDRs require full compliance with each country's reporting rules because they are listed in multiple countries, but this overlooks the simplified reporting framework GDRs actually use, which contrasts with the broader flexibility of being listed on multiple exchanges as the correct answer indicates.

Unit: overview-of-equity-securities

Question 7Exam level

Which of the following is a characteristic that most likely distinguishes common stockholders from preferred stockholders?

How sure are you?

Correct: B. Voting rights for corporate matters (board elections, major transactions, charter amendments) are the defining right of common stockholders. Preferred stockholders typically have NO voting rights in routine corporate governance matters (though they may gain voting rights if dividends are in arrears). Common stockholders have the LOWEST priority in liquidation (below all creditors and preferred shareholders). Preferred dividends are typically fixed; common dividends vary. Both common and preferred shareholders have limited liability. Limited to their investment, not par value.
A. You might be tempted to choose A because fixed dividend rates sound like a clear distinction, but in reality, it is preferred stockholders who receive dividends at a fixed rate, not common stockholders, who have variable dividends and the key distinction of voting rights.
C. Both common and preferred stockholders carry limited liability, capped at what they invested, not at the shares' par value, and preferred stockholders do not carry unlimited liability at all. Limited liability is a feature of the corporate form itself and applies equally to both share classes, so it cannot be the characteristic that tells common and preferred stock apart. Voting rights are what actually separates them.

Unit: overview-of-equity-securities

Question 8Exam level

A company issues callable preferred stock with a call price of $110 per share when prevailing market interest rates are 6%. If interest rates subsequently fall to 4%, the company will MOST likely:

How sure are you?

Correct: A. Callable preferred stock gives the ISSUER the right to redeem shares at the call price. When interest rates fall, the issuer can refinance at lower cost. Exactly analogous to a mortgage holder refinancing when rates drop. The company calls the expensive fixed-rate preferred (e.g., 6% dividend) and issues new preferred at the prevailing lower rate (e.g., 4%). This is why callable preferred is advantageous to issuers but creates reinvestment risk for investors. The call provision caps the price appreciation investors can expect when rates fall.
B. You might be tempted to choose B because it seems like a way to reduce dividend payments, but callable preferred stock does not have a conversion feature into common stock; instead, the call feature allows the company to redeem the shares at a specified price, enabling them to reissue new preferred stock at a lower dividend rate when interest rates fall.
C. You might be tempted to choose C because it involves a similar concept of returning shares to the issuer, but preferred stock typically does not have a put provision that allows shareholders to force the company to buy back shares; instead, callable preferred stock gives the company the option to buy back shares at a specified price, which aligns with the correct answer A.

Unit: overview-of-equity-securities

Question 9Above the exam

An investor is comparing an investment in the common shares of a private company to an investment in the American Depositary Receipts (ADRs) of a foreign public company trading on a US exchange. Combining the liquidity and information characteristics of private versus public equity with the specific mechanics of an ADR, the investor should most likely conclude that:

How sure are you?

Correct: B. An ADR is a negotiable certificate, issued by a depositary bank, representing shares of a foreign company, that trades on a US exchange just like a domestic stock, giving US investors convenient, liquid, exchange-traded access, and the ADR issuer is subject to applicable US public-company disclosure requirements. Private company shares, by contrast, have no organized public market (illiquid, often hard to value or exit) and face far lighter disclosure requirements than a public, exchange-listed security. Combining these liquidity and disclosure characteristics correctly distinguishes the two.
A. Private and public equity differ dramatically in both liquidity (an organized public market versus none) and disclosure (extensive public-company requirements versus minimal), which is exactly why the equity-securities LOS distinguishes them; 'identical characteristics' ignores both dimensions entirely.
C. There is no general rule that private companies are automatically undervalued relative to public ones; valuation depends on the specific business, and if anything, the ILLIQUIDITY of private shares typically commands a valuation DISCOUNT, not a premium, all else equal.

Unit: overview-of-equity-securities

Question 10Above the exam

A company has issued both non-convertible preferred stock and common stock. During a year of financial distress, the company suspends its common dividend but the preferred stock is cumulative. Combining the definition of cumulative preferred stock with the priority of claims across the company's capital structure, an investor should most likely conclude that:

How sure are you?

Correct: A. Cumulative preferred stock means any skipped dividends accrue as an unpaid obligation (dividends in arrears) that must be paid in full before the company can resume paying COMMON dividends; it does not mean the dividend is guaranteed to be paid in the year it is skipped. Preferred stock, cumulative or not, still generally carries no voting rights in ordinary circumstances and ranks below all debt holders (senior and subordinated) in a liquidation, even though it ranks above common equity.
B. Cumulative status affects the treatment of UNPAID DIVIDENDS (they accrue as a claim ahead of common dividends), not voting control; preferred shareholders typically remain without general voting rights even after dividends are skipped, absent a specific contractual provision granting contingent voting rights (which is not implied by 'cumulative' alone).
C. Cumulative preferred stock does not guarantee the dividend WILL be paid in a distress year; the company can still suspend it. 'Cumulative' only means the suspended amount accrues and must eventually be paid (before common dividends resume), not that payment is forced in the year it would otherwise be skipped.

Unit: overview-of-equity-securities

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